×

Reserve Bank of Australia leaves rates on hold after strong Q1 GDP

Australia's central bank held its powder dry at Tuesday's scheduled policy review as the nation's robust first-quarter report card curbed the need for additional monetary stimulus.

RBA headquarters in Sydney, Australia
Dan Himbrechts | Bloomberg | Getty Images
RBA headquarters in Sydney, Australia

The Reserve Bank of Australia (RBA) left its benchmark cash rate unchanged a month after it unveiled a 25 basis point cut, which took rates to their current record low of 1.75 percent.

Australia's 'Big Four' banks and a Reuters poll of economists had anticipated no action on Tuesday after gross domestic product (GDP) for the January-March period expanded 3.1 percent on-year. It was the fastest pace of acceleration in three years and placed the world's twelfth-largest economy on track to meet the RBA's growth forecast of 2.5 to 3.5 percent by year-end.

"With unexpectedly strong Q1 GDP, admittedly flattered by net export volumes whereas investments were dismal, the RBA faces a high bar to justify another urgent rate cut," said Vishnu Varathan, senior economist at Mizuho Bank.

Following the announcement, the Australian dollar leapt to a one-month high of 74 U.S. cents against the greenback, with analysts attributing the spike to the RBA's lack of concern about the currency in its policy statement on Tuesday. The strength of the local dollar in recent years was a key catalyst for previous interest rate cuts.

Among other factors underlining the case for steady policy, oil prices have moved off their recent lows, which is good news for energy exporting nations like Australia, Varathan pointed out.

But that's not to say the RBA will be holding steady for long; persistently low inflation remains a worrisome factor that could lead to further rate cuts this year.

In Tuesday's statement, the central bank said inflation was expected to remain low "for sometime" due to subdued growth in labor costs, a prediction shared by several economists.

Minutes from the bank's May policy meeting revealed tepid price pressures were the primary motivation for lower rates, with first quarter consumer price inflation (CPI) sliding 0.2 percent on-quarter and rising by 1.3 percent on-year, well below expectations. The report forced the RBA to downgrade its underlying inflation forecast to 1-2 percent for 2016, from a previous target of 2-3 percent.

Since the RBA's last meeting, fresh data points have yet to signal any improvement. A private inflation gauge by TD Securities and The Melbourne Institute released on Monday showed a 1 percent increase on-year in May, compared with the previous month's 1.5 percent expansion.

"If a number in that region is borne out in the official second quarter CPI, you can pretty much guarantee two further rate cuts, maybe even three," warned Angus Nicholson, IG market strategist.

Indeed, the central bank is widely anticipated to await the next batch of inflation data before considering any further action.

"We're expecting the inflation gauge to remain quite subdued throughout most of 2016 and will probably prompt another rate cut after the June figures come out," said Emily Dabbs, economist at Moody's Analytics.

Other areas of concern mentioned in Tuesday's statement were large declines in business investment and a more cautious attitude among lenders towards certain segments.

Meanwhile, a looming U.S. interest rate hike isn't expected to drastically alter the RBA's views, according to Dabbs. But once the Federal Reserve does normalize rates sometime this year, Australia stands to benefit, she said.

"That divergent monetary policy is a bonus for Australia, it puts downward pressure on the Australian dollar, which is great for our export-facing businesses, and that should support growth."

Follow CNBC International on Twitter and Facebook.