* RBA cuts cash rate by 100 basis points to 4.25 pct
* Market pricing in further drastic easing next year
* Retail sales rise 0.7 pct in Oct, beating forecasts (Recasts with rate cut, reaction)
By Wayne Cole
SYDNEY, Dec 2 (Reuters) - Australia's central bank slashed interest rates to a 6-½ year low, bringing the easing since September to 3 percentage points and leaving the door open to more cuts as it fights to save its economy from recession.
The Reserve Bank of Australia (RBA) cut its cash rate by an unexpectedly bold 100 basis points to 4.25 percent -- the lowest since May 2002 -- after its monthly policy meeting. It was the bank's fourth rate cut in as many months.
"It's taken the cash rate back to a historical low but it won't be the last one," said John Edwards, chief economist at HSBC. "I expect the cash rate to be under 4 percent by March."
Explaining the move, Governor Glenn Stevens noted the perilous state of the global economy and suggested there could be more cuts.
The futures market is already well ahead of him, pricing in swingeing cuts to near 3.0 percent next year, depths that have not been seen in money markets since the early 1960s.
Neither is the central bank alone in its urgency. The European Central Bank, Bank of England and Reserve Bank of New Zealand are all expected to chop rates this week in an effort to revive growth.
RBA's Stevens said a big slowdown in domestic demand was underway which would soon pull inflation lower and warranted moving policy to an expansionary setting.
Figures on gross domestic product due on Wednesday are expected to show the economy grew a paltry 0.2 percent in the third quarter, and perhaps even suffered an outright contraction. Annual growth is seen braking to 1.9 percent, down from more than 4 percent this time last year.
"The economy is poised on a knife edge and the RBA is going to keep cutting until it starts to get traction with consumers and housing," said Macquarie senior economist Brian Redican.
MORTGAGE RELIEF
The central bank's task was aided by most of the main commercial banks which hurried to cut their variable mortgage rates -- which are the most commonly used in Australia -- by the full 100 basis points on Tuesday.
That should deliver a big and almost immediate boost to household income, and contrasts with the United States where the Federal Reserve has had trouble bringing down mortgage rates.
All of this was welcomed by Australia's government, which is keen to avoid a politically damaging recession.
"This is a vital rate cut from the Reserve Bank, delivered at a time when all our joint efforts are directed to strengthening the economy," said Treasurer Wayne Swan.
The government has weighed in with a A$10.4 billion ($6.7 billion) stimulus package, much of which hits wallets next week, and is spending more on roads, hospitals and schools.
There have been hints all this stimulus might be helping consumer confidence.
Retail sales showed a surprise 0.7 percent increase in October, when analysts had looked for a 0.4 percent drop.
Furniture and electricals retailer Harvey Norman on Tuesday said like-for-like sales for the 28 days to Nov. 30 rose 0.5 percent compared to the same period last year, thanks in part to discounting.
Grocery wholesaler Metcash also reported it had satisfactory sales in November and saw no weakening in its markets, though it is in a traditionally defensive sector.
But such resilience could prove all-too fleeting in the face of fresh falls in equity markets and deepening global gloom.
Australia's share market sank over 3 percent on Tuesday after bourses in Wall Street and Europe dived in reaction to truly awful readings on industrial activity.
The United States was officially declared to have been in recession for all of this year.
Even more alarming for a relatively small and open economy like Australia, its two biggest trading partners, Japan and China, were reporting ever-grimmer conditions.
"It further elevates the risks of deflation as the main driver of the global economy in recent years -- China -- deals with what, for it, is a period of ultra weak activity," said Stephen Koukoulas, global strategist at TD Securities.
"That spells big trouble for the Australian economy," he added. "The RBA is set to cut rates ultra aggressively, bond yields should fall further."
Australian 10-year bond yields had already tumbled as far as 4.31 percent, the lowest since 1951 and down from a peak of 6.81 percent as recently as June. (Editing by Jan Dahinten)