SYDNEY, Oct 7, 2008 (AFP) - Australia's central bank applied shock therapy to the economy Tuesday in the face of global financial panic, slashing interest rates by twice as much as the markets expected.

The Reserve Bank of Australia (RBA) cut a full 100 basis points off its key cash rate to 6.0 percent amid fears that the US-based financial crisis could spark a global economic slowdown.

Australian shares staged a dramatic turn-around on the news, closing up 1.7 percent after having fallen more than 3.0 percent in early trade.

The one percentage point cut in interest rates was the biggest since 1992 and came just a month after a 25 basis point cut marked the first downward movement in nearly seven years.

Rates had previously inched steadily upwards as Australia's economy boomed and the bank viewed inflation as the main threat.

But the recent deterioration in the prospects for global growth presented a risk that demand and output could be significantly weaker than expected, said RBA governor Glenn Stevens.

'Should that occur, inflation would most likely fall faster than earlier forecast,' he said in a statement.

Inflation over the four quarters to September was likely to be about 5.0 percent -- well above the bank's preferred range of 2.0-3.0 percent -- but was likely to decline in 2009, Stevens said.

He noted that there was evidence of 'a significant moderation in growth in Australia's trading partners in Asia'.

Rapid growth in Asian giants China and India and their insatiable demand for resources has long been the engine driving Australia's own growth.

Taking the global crisis into account, the bank decided that 'an unusually large movement in the cash rate was appropriate in order to bring about a significant reduction in costs to borrowers,' Stevens said.

Australian mortgage holders had been hard hit by the earlier series of rate hikes, although politicians have stressed repeatedly that the country does not face a US-style sub-prime mortgage meltdown.

Prime Minister Kevin Rudd said the bank's decision would help maintain the stability of the financial system and see Australia through 'tough times ahead.'

'The government welcomes the relief the Reserve Bank of Australia's decision will provide to working families and Australian small businesses,' Rudd said.

'We are dealing with extraordinary economic times ... when some 25 banks around the world have either failed or have had to be bailed out.'

The Australian dollar closed at a two-year low after the rate cut announcement, continuing a steep decline since hitting a 25-year high of 98.49 US cents in mid-July.

By late afternoon the Australian dollar was trading at around 73 cents.

The central bank's move came as Asian stock markets plunged again Tuesday, with governments taking emergency measures to shore up confidence.

Markets in Asia opened sharply down, with shares in Tokyo falling more than five percent at one point, a day after a global rout saw New York's Dow Jones Industrial Average fall below 10,000 points for the first time since 2004.

In Europe, finance ministers were to begin preparing their first joint measure Tuesday to reassure nervous savers by ramping up minimum bank deposit guarantees.

In a joint declaration Monday they pledged to protect the stability of financial institutions by providing 'liquidity support through central banks, action to deal with individual banks or enhanced depositor protection schemes.'