The Reserve Bank has cut its expectations for Australia's growth over the next year, keeping the door open for further interest rate policy cuts on warnings of a faster-than-expected fall in mining investment.
The lower projection "reflects the substantial fall in mining investment, planned fiscal restraint and the still high level of the Australian dollar", the RBA said in its latest quarterly Statement of Monetary Policy released on Friday.
The weaker forecasts came despite the recent pick-up in the housing market and business and consumer confidence, which the central bank said would flow through to non-mining business investment and lead to stronger growth in 2015.
The RBA continued its rhetoric against the local currency, saying a lower Australian dollar was "likely to be needed to achieve balanced growth in the economy".
The central bank increased its growth forecast for this year to 2.5 per cent, but lowered its projections for the next two years by 0.5 percentage points. It expects the economy to grow by 2 per cent to 3 per cent in 2014. In 2015, it forecasts growth of between 2.25 per cent to 3.25 per cent.
"This is a decidedly more dovish statement than was expected," Westpac's chief economist Bill Evans said. "While we anticipated the bank using fairly moderate language around prospects for the economy in order not to 'talk up' the Australian dollar, we did not expect such a growth downgrade. A lower exchange rate, if it came about, would also see growth strengthening sooner than forecast and place upward pressure on inflation."
The Australian dollar slipped almost half a cent to US94.28¢ after the SOMP was released, but recovered most of its losses, in part due to a stronger-than-expected lift in exports from China, Australia's largest trading partner. It was buying US94.64¢ late on Friday.
The statement came hot on the heels of remarks from the RBA's assistant governor for financial markets, Guy Debelle, in Washington on Thursday. Mr Debelle said the currency's recent strength was "not in line with fundamentals" and that its extended elevated levels could lead to Dutch disease - the negative impact a strong currency driven by a resources boom can have on a country's other industries.
On Tuesday in his November board meeting statement, RBA governor Glenn Stevens described the dollar as "still uncomfortably high". Last week, Mr Stevens said the "levels of the exchange rate are not supported by Australia's relative levels of costs and productivity".
With mining investment projected to fall off faster than expected, UBS chief economist Scott Haslem said the central bank was likely to increase its efforts to talk down the dollar.
"Over time, the markets will take little weight in their comments, particularly if it is not backed up by some actions," Commonwealth Bank currency strategist Peter Dragicevich said.
"But I think we are still a fair way away from that. We could see more forceful rhetoric in the commentary from the RBA if they deemed it, so there are still a few more steps that the RBA could take."
In Europe on Thursday, another central bank which has been grappling with a strong currency, the European Central Bank, dealt the euro a blow when it made a surprise cut to the cash rate to a record low of 0.25 per cent.
The euro fell to a seven-week low against the US dollar.
At the same time, the US economy recorded strong third-quarter growth, with GDP rising to 2.8 per cent at an annual pace, up from 2.5 per cent in the second quarter, figures released on Friday showed.
The Reserve Bank said it would not "close off the possibility of reducing" the cash rate further should the economy need further stimulus. It added that while "growth is forecast to remain a bit below trend for a time, there is a reasonable prospect that private demand beyond the resources sector will strengthen over time".
Financial markets shifted up their expectations of another rate cut before mid-2014, pricing in an almost 25 per cent chance of an easing by May. Markets also pared back their forecasts of the first rate hike since November 2011 to less than 1 per cent in June.