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Aussie on tenterhooks ahead of RBA meeting

Reserve Bank of Australia in Sydney
Saeed Khan | AFP | Getty Images
Reserve Bank of Australia in Sydney

With the Australian dollar trading around the Reserve Bank of Australia's (RBA) preferred level of $0.75, will the central bank hold off on cutting rates at Tuesday's meeting?

Markets are pricing in an 80 percent chance of a cut, but analysts were largely divided over whether it would come in April or May. The S&P ASX 200 was up more than 1 percent Tuesday ahead of the decision.

According to Mitul Kotecha, head of FX strategy, Asia-Pacific at Barclays, the RBA is likely to pull the rate cut trigger sooner rather than later given the recent collapse in iron ore prices – a key export for Australia.

"It's interesting, the RBA had said they were comfortable with the Aussie dollar at $0.75, but the reality [is] now commodity prices, [such as] iron ore, have fallen even further. They probably want to see[the Australian dollar] even lower now," Kotecha told CNBC.

Last week, iron ore prices fell below $50 a tonne for the first time in a decade on concerns over a supply glut and soft Chinese demand. Iron ore accounts for close to one-fifth of the value of Australia's total exports.

"I think $0.75 is gone, I think it's probably in the region of towards $0.70 if anything," Kotecha said, adding that Barclays recently moved its call for a rate cut forward to April from May.

The RBA last cut rates in February by 25 basis points to 2.25 percent – a new record low.

Kotechais not alone in his outlook for an April rate cut.

Shane Oliver, head of investment strategy and chief economist at AMP Capital said whileit's once again a close call given strength in pockets on the country's property market, the central bank will likely opt for easing.

"The additional 21 percent fall in the iron ore price since the RBA's last meeting has added urgency to the case for the RBA to cut rates again at a time when the growth outlook remains subdued, the outlook for business investment is poor, inflation remains benign," he said.

"The trend in the [Australian dollar] is likely to remain down as the Fed is still likely to raise rates this year whereas the RBA remains on track to cut and the long-term trend in commodity prices remains down," he added.

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Oliver expects a fall to $0.70 this year, and further declines into $0.60 range in the years ahead.

The Australian dollar fell 7 percent against the U.S. dollar in the first quarter of the year, putting it in the ranks of the world's worst performing major currencies. A combination of a strengthening U.S. dollar, falling commodity prices and lower interest rates has driven the currency lower.

Moody's Analytics believes it's an even chance between April and May.

"We favor a 25 basis point cut in May to get confirmation March quarter(consumer price index) data were low. The RBA indicated in March it was happy to sit still to get a better gauge of how the economy was responding to February's rate cut, more uncertain given the low interest rate environment," Moody's Analytics said.

It expects an additional 50 basis points in rate cuts this year.