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Rate Cut Talk in Australia: Why the Buzz Is Back

Shopper in Sydney's David Jones store
Ian Waldie | Bloomberg | Getty Images
Shopper in Sydney's David Jones store

Data on Wednesday showing that inflation in Australia is well under control has created a buzz in markets about more interest rate cuts, with some analysts hoping for a move as early as next month.

Headline inflation in Australia rose just 0.4 percent in the first quarter, well below market expectations for a 0.7 percent rise. That left the annual rate of consumer prices at 2.5 percent – comfortably within the 2-3 percent range targeted by the central bank, the Reserve Bank of Australia (RBA).

"The weaker than expected inflation readings for the March quarter tells us that inflation is not an issue and is certainly not a barrier to further easing," said Shane Oliver, head of investment strategy and chief economist at AMP Capital in Sydney in a note.

"It should see the RBA act on its easing bias, and cut interest rates another 0.25 percent, hopefully at its May Board meeting," he added.

The specter of a rate cut sooner rather than later certainly had markets in Sydney excited: the benchmark stock index rose more than 1.5 percent to its highest level in five weeks, with interest-rate sensitive banking stocks such as National Australia Bank and Westpac gaining 2 percent each.

Even the Australian dollar, which has proved resilient to rate cuts in the past year, fell towards Tuesday's six-week low around $1.0219 after the softer-than-expected data.

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"I think we will get another couple of rate cuts this year," Angus Geddes, CEO of investment firm Fat Prophets in Sydney told CNBC.

To bolster the economy, the RBA has slashed interest rates 175 basis points since late 2011. It last eased monetary policy in December and has left its key interest rate steady at 3 percent since then given some signs of a pick-up in the economy.

And while markets had scaled back rate-cut expectations, recent weak economic data in the U.S. and China, the world's two biggest economies, and a sell-off in commodities have raised concerns about the outlook for Australia's economy.

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"Over the past few weeks we have seen a softer tone to global economic data, sharp falls in commodity prices, which will put more downwards pressure on Australia's terms of trade and national income and mixed economic data in Australia," said Oliver at AMP.

"While past interest rate cuts are getting some traction the economy remains vulnerable and in need of more support ahead of the slowdown in mining investment that will occur this year," he added.

For some economists, the case for a rate cut soon was not clear-cut.

"There is a bit of a quandary when it comes to cutting rates," said Matthew Circosta, an economist at Moody's Analytics in Sydney. "There have been signs of a pick-up, for instance in housing but will that continue to outweigh a weakening in mining investment?"

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Circosta added that the RBA had reasons to be cautious about Tuesday's soft inflation data.

"Imported inflation would be higher without the strong Australian dollar, so the domestic price pressures are still there and I think that will keep the central bank cautious," he said.

The Australian dollar has strengthened about 20 percent since mid-2010, helping to contain inflation.

By CNBC.Com's DharaRanasinghe; Follow her on Twitter @DharaCNBC