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Was Australia's Central Bank Right to Cut Rates?

Shoppers in Bondi Beach in Sydney, Australia
Ian Waldie | Bloomberg | Getty Images
Shoppers in Bondi Beach in Sydney, Australia

Australia's much better than expected jobs data on Thursday have many market watchers wondering if the Reserve Bank of Australia (RBA) did the right thing by cutting interest rates earlier this week.

On Tuesday, the central bank delivered a 25 basis point rate cut to bring rates to a record low of 2.75 percent, confounding some analysts who had expected rates to be kept steady on signs of a pick-up in economic growth.

Thursday's employment data -- which showed Australia added 50,100 jobs in April, more than four times the forecast - point to strength in the economy.

(Read More: Australia Employment Surges in April, Jobless Drops)

So what was the RBA thinking?

Adrian Mowat, chief Asian and emerging markets equity strategist at JP Morgan Securities, said the jobs data are surprising given the fact that the RBA cut rates this week and the market reaction to that was "boy, what do they know that we don't?"

"Then we've got this stronger employment data, although it is true that they did revise down some of the March numbers, the market is confused, which is why its only up by 18 basis points," Mowat said after the data came out during morning trade. The benchmark S&P ASX 200 is now down 0.2 percent despite the upbeat jobs data.

The RBA's decision to move on rates may have had more to do with the growing trend among global central banks like Japan to ease - creating currency pressure, according to Mowat.

"The European Central Bank has cut interest rates; we've had rate cuts from the Bank of Korea. There's pressure on the Thai central bank to cut rates, because of currency pressure there," Mowat said. "So with what's going on in Japan, probably through the currency, there is pressure of interest rates to come down."

The recent steep fall in the Japanese yen owing to aggressive easing, has put pressure on others to protect their currencies from losing their competitiveness. The Australian dollar has been one of the most resilient currencies in the region, having appreciated nearly 2 percent over the past 12 months.

(Read More: Australian Exports to China Hit Record, Boost Growth)

According to Kieran Davies, chief economist at Barclays, the RBA has been on record citing concern over the high Australian dollar, saying they have cut rates recently by more than they otherwise would to offset the impact of the strong currency on the economy.

"The quantitative easing you've seen in the major countries has propped the exchange rate and what's happened offshore has fed through into the RBA's decision," Davies added.

Inflation Key in Rate Cut

Paul Bloxham, Australia and New Zealand chief economist, HSBC, meanwhile said the RBA's decision to cut rates was more based on inflation rather than other indicators.

"I think it solely reflects inflation which was low enough so they decided to cut rates, it was a very close call," Bloxham said. "I think it's hard to say necessarily that it was the wrong move at this point, but certainly the information as we read it tells us that they may not need to cut any further."

Data in April showed that underlying inflation was running at about 2.4 percent for the year, within the central bank's long-term target of 2-3 percent.

(Read More: NAB Profit Drives Australia's 'Big Four' Bank Earnings to Record)

Bloxham expects the central bank to keep rates on hold at 2.75 percent for the rest of the year as the jobs number are consistent with his view that Australia's soft patch in economic growth may be over now. The Australian economy grew 3.1 percent in 2012.

Barclay's Davies also backed that view of inflation being key, saying that the Australian economy is not in as dire a situation as other countries globally that have had to cut rates.

"It's not so much that they worry about matching what the other central banks have done, because they're economic circumstances are much different, they are in much worse shape," Davies said.

The RBA cut rates on Tuesday for the first time since December.

— By CNBC.com's Rajeshni Naidu-Ghelani; Follow her on Twitter @RajeshniNaidu