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Dollar, stocks dumped as storm clouds gather

INVESTORS are betting on the Reserve Bank slashing interest rates by almost 50 basis points before Christmas amid fears that a new financial storm will batter world markets.

INVESTORS are betting on the Reserve Bank slashing interest rates by almost 50 basis points before Christmas amid fears that a new financial storm will batter world markets.

The sharemarket plunged to its lowest level in a year as investors fretted over the weakness of the US economy.

The benchmark S&P/ASX 200 Index fell 100.8 points, or 2.3 per cent, to 4332.8 points. Investors dumped risky assets, including the Australian dollar, which fell almost US1.5? to $US107.39 , and put their cash into havens such as gold, which rose 2.7 per cent to $US1669.43 a fine ounce.

A senior foreign exchange dealer at CMC Markets, Tim Waterer, said yesterday's negative retail data compounded poor market confidence, causing the local currency to fall against the greenback.

"This was not what the doctor ordered and the Australian dollar has fallen further out of favour on that bad news," Mr Waterer said.

It could drop even further with the Sydney Futures Market now pricing in at least two interest rate cuts, despite the Reserve Bank flirting with raising the official cash rate on Tuesday.

The Reserve held the cash rate at 4.75 per cent, surprising many commentators and investors who had tipped a rise after inflation soared above the bank's 3 per cent limit last quarter.

Saul Eslake, a director at the Grattan Institute, said gloomy retail sales figures - the worst since the 1990s recession - prompted investors to believe the Reserve Bank's next move was a cut. However, Mr Eslake said there were no indications of a rate cut soon.

The International Monetary Fund warned the Reserve might need to resume raising rates to prevent inflation accelerating.

"It's hard to interpret [Tuesday's] statement from the [Reserve] board as signalling anything other than the next movement in interest rates, whenever it comes, will be up," Mr Eslake said.

"There was nothing in that statement that suggested [the Reserve] was concerned that the present weakness in various areas of the economy warranted any response from monetary policy."

The odds of a 50 basis-point rate cut in December rose to more than 100 per cent in the interbank cash-rate futures market yesterday, compared with 5 per cent before the announcement on Tuesday. A Credit Suisse Group AG index showed traders betting the Reserve would cut borrowing costs by 75 basis points over the next 12 months.

But the Westpac chief economist, Bill Evans, who has predicted a December rate cut for the past month, said investors were over-reacting. He said the market had flipped between predicting cuts and rises for the past fortnight. "I don't treat it as being particularly encouraging that our view is being justified because it can disappear tomorrow at the moment," Mr Evans said.

"It looks as though there were quite a lot of people positioned for a hike [on Tuesday] and in trying to unwind their positions the market has moved further than expected."

The HSBC chief economist, Paul Bloxham, said the central bank still had a "tightening bias" and was likely to lift rates in the fourth quarter.

"The continuation of the mining investment boom continues to offset the impact of the higher exchange rate and interest rates on the non-mining sector. We still think the Australian story is a very positive one."

INSIDE

Ian Verrender, Elizabeth Knight and Michael West on the bumpy ride we can expect. Pages 8 and 9.


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