By Business editor Peter Ryan
The Reserve Bank has warned that any new escalation of the Eurozone debt crisis remains the biggest risk to the Australian economy.
In the minutes from its March 6 meeting, the RBA board has provided a reality check on the still fragile state of the global economy and Australia's exposure to Europe.
"The clearest downside risk to the outlook for Australia remained a sudden worsening in the situation in Europe and its flow-on effects to the rest of the world through trade, financial and confidence channels," the boardroom minutes warn.
"Members noted that a sharp slowdown, particularly in east Asia, would have significant implications for commodity prices and demand for Australian exports.
The minutes warn that a resulting "flight from risk" in global markets would see significant changes in credit conditions, the exchange rate and confidence.
While the RBA believes a worst case scenario from Europe is now less likely, it warns "this downside risk could still materialise."
The board minutes show that although the RBA believes the current cash rate setting is appropriate for now, it still has "ample scope" to ease policy as long as inflation remained contained.
The RBA board left interest rates on hold at 4.25 percent this month citing improved conditions in Europe and local comfort about inflation. The RBA cut rates by a total of 0.25 percent in both November and December last year as fears about Europe intensified.
The RBA board also underscored the strength of Australian banks which have been under pressure from higher funding costs on global markets.
"Members noted that the Australian banking system remained in a relatively strong condition," according to the minutes.
"The larger banks were in a better position than a few years ago to cope with the tighter funding conditions given the improvements made to their funding.
"The wholesale funding task had also become more manageable, with deposit growth continuing to outpace credit growth by a wide margin."
The minute also note the impact of the high Australian dollar and the creation of a multi speed economy.
But the RBA believes the booming mining sector is compensating for losses in struggling manufacturing industries which rely on a lower currency.
"Most information thus far has indicated that weakness in parts of the economy - including manufacturing, building construction and parts of the retail sector - was being approximately balanced by the strength in the mining sector and some services industries."
The Reserve Bank also noted that while global sharemarkets had grown ten percent since the beginning of the year, the Australian market was relatively weaker because of a larger weighting on the mining sector.