* Retail sales dive 2.0 pct in Feb, biggest fall in 9 years
* Overshadows sharp 7.8 pct bounce in home building approvals
* Market torn on chances of RBA cutting rates next week
By Wayne Cole
SYDNEY, April 1 (Reuters) - Australian retail sales slumped by the most in nine years in February as fears of unemployment swamped the fading effect of government hand outs, adding to the case for another cut in interest rates as early as next week.
The Australian dollar
The grim data will intensify pressure on the Reserve Bank of Australia (RBA) to ease rates at its April policy meeting next week, even though policymakers have shown an inclination to pause again, having skipped a chance to cut in March.
"The extent of weakness in retail sales really skews the case for the RBA to go back to cutting by 25 basis points next week," said Besa Deda, chief economist at St George.
Investors, however, were not so sure as an influential central bank-watcher, Terry McCrann, argued the RBA would leave rates unchanged next week.
He gave no source for his belief, but has been right on enough RBA moves in the past to earn the attention of the market.
"The RBA has good reasons to extend the pause," said Warren Hogan, head of Australian economics at ANZ, citing increased demand for home loans and the prospect of more fiscal spending.
Some A$7.7 billion worth of bonus payments to 8.7 million taxpayers are due to start this month, which could again give a temporary lift to sales.
"If anything a rate cut now will reduce the scope for RBA action later," he added. In particular, unemployment is likely to rise a lot further and policy makers may want to save some rate ammunition as a salve for consumer confidence.
The RBA has already cut its key cash rate by 400 basis points since September, taking it to a record low of 3.25 percent.
With the retail sector accounting for around 23 percent of Australia's gross domestic product (GDP) and about 15 percent of all jobs, the weakness in sales directly raised the risk of outright recession.
"It continues with the run of pretty weak numbers for this quarter," said Deda. "Right now, our preliminary estimate is for a contraction in GDP of 0.4 percent."
Since the economy had already shrunk by 0.5 percent in the last quarter of 2008, such an outcome would match the technical definition of recession -- the first for Australia since 1991.
RECESSIONARY
February's slide in sales reversed around half of the gains enjoyed in December and January when over A$8 billion in fiscal handouts gave a temporary boost to shopping power.
But with the economy skidding inexorably into recession and unemployment jumping to four-year highs, consumers were increasingly choosing to save rather than spend.
The RBA itself on Tuesday had conceded that a lot more pain lay ahead, predicting the economy would contract over 2009.
Surveys suggest the manufacturing side of the economy has been in recession for months. A private survey of 200 firms out on Wednesday showed activity stuck near record lows in March, with new orders, production and employment all falling.
The only glimmer of light on Wednesday were figures showing a surprisingly steep 7.8 percent bounce in approvals to build new homes in February.
Approvals for multi-unit projects jumped 34 percent, suggesting credit conditions were easing and past cuts in interest rates were finally fuelling demand for new homes.
The Australian dollar initially fell to a low of $0.6854 from $0.6880 before the release of the retail data, but recovered most of the loss to trade around $0.6897.
Australia's benchmark stock index <.AXJO> rose 0.3 percent on hopes of an interest rate cut next week, while Aussie bond futures narrowed earlier losses. (Editing by Kim Coghill)