That is a steep downgrade from its previous forecast for Australia's A$1.8 trillion ($1.3 trillion) economy to expand at 3.3 percent this year and 3.0 percent next.
The downbeat outlook sent the local dollar AUD=D3 to five-week lows while the three-year government bond contract YTTc1 jumped to the highest since November 2016. Rate futures now imply a full 25 basis point cut to 1.25 percent later this year and a small chance of further easing next year.
"The downgrades in today's report were bigger than we had expected," said JPMorgan analyst Tom Kennedy. "It shows the RBA certainly had a rethink of their expectations of the economy at the start of 2019.
"I think, it was certainly the housing narrative that pivoted them away from balanced optimistic to balanced negative."
The RBA has left interest rates at 1.50 percent since August 2016 and had repeatedly signalled the next move would be an increase.
But on Wednesday, Governor Philip Lowe surprised investors by tilting to a neutral stance from a previous tightening bias, citing several downside risks to growth. (Full Story)
On Friday, Lowe laid out two scenarios - one in which unemployment eases further from the current seven-year low of 5.0 percent pulling inflation higher and another where there was a sustained increase in the jobless rate.
While the central bank previously saw the odds skewed towards a decline in unemployment rather than an increase, Lowe said the possibility of either scenario playing out is now "more evenly balanced".
However, he noted the central bank board still did not see a strong near-term case to change interest rates.
Apart from slowing global growth, Australia's sliding property market has become an ever more important concern for policymakers with the outlook for consumption partly hinging on the waning wealth effect.
Home values across the country have skidded 8 percent since September 2017 after doubling in the preceding five years led by tightening lending standards at the country's biggest banks and a glut of new supply.
"The current correction in the housing market is a significant area of uncertainty," Lowe said.
"The implications of the housing market correction for the broader economy depend on how households respond, including how they take previous increases in account in their spending decisions."
One likely driver of personal consumption is wages growth, which has picked up slightly from a record low 1.9 percent but is seen hovering close to current levels through the RBA's forecast period.
Lowe remains optimistic about a revival in spending given the labour market strength, but his own forecasts pointed to subdued consumption growth of around 2.5-2.7 percent into 2021. That compares with 4-6 percent before the global financial crisis.
Markets are less optimistic though.
"We suspect that the economic deterioration this year will cause the Bank to become even more dovish and eventually cut rates to 1.0 percent by early 2020," said Ben Udy, Singapore-based economist for Capital Economics.
($1 = 1.4126 Australian dollars)
(Reporting by Swati Pandey; Editing by Wayne Cole and Sam Holmes)
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