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Aussie dollar rallies as central bank holds rates, cut still on the menu

Key Points
  • The Reserve Bank of Australia (RBA) ended its monthly policy meeting by keeping rates unchanged at 1.5 percent, where they have been since mid-2016. 
  • There had been much speculation it would ease given recent weak inflation outcomes.
Australian one-hundred dollar banknotes.
Brent Lewin | Bloomberg | Getty Images

The Australian dollar rallied on Tuesday after the country's central bank defied pressure for an immediate cut in interest rates, though it left the door wide open for an easing should the jobs market not stay strong.

The Aussie dollar popped up almost half a cent to $0.7042 on the decision, giving it a gain for the day of 0.7 percent. It faces tough resistance around $0.7070, however.

The Reserve Bank of Australia (RBA) ended its monthly policy meeting by keeping rates unchanged at 1.5 percent, where they have been since mid-2016. 

There had been much speculation it would ease given recent weak inflation outcomes.

Yet the central bank set the conditions for an easing by noting that inflation was too low and unemployment would have to fall further to get it rising.

"The Board ... recognized that there was still spare capacity in the economy and that a further improvement in the labour market was likely to be needed for inflation to be consistent with the target," RBA Governor Philip Lowe said in a statement.

Investors reacted by lengthening the odds on a cut in the next couple of months, though it was fully priced for September.

"The Bank noted that it will be paying close attention to developments in the labour market at its upcoming meetings, so if the unemployment rate doesn't fall any further, we suspect that the Bank will start to cut," said Marcel Thieliant, a senior economist at Capital Economics.

Interbank futures had implied a 36 percent chance of a quarter-point cut this week, while 17 of 42 analysts polled by Reuters have tipped an easing with the rest on hold.

The July futures contract now implies a 52 percent probability of an easing, compared to 100 percent before the meeting. August shows a 90 percent chance of a cut.

Australian government bond futures surrendered some of their recent gains, with the three-year contract off 8.5 ticks at 98.685. The 10-year contract fell 5 ticks to 98.2000.

Yields on three-year bonds rose to 1.31 percent, having touched an all-time low of 1.23 percent on Monday.

If the RBA does eventually cut, markets will automatically assume it will go again, as the bank has never moved rates just once and stopped. It eased twice in 2016 and twice in 2015.

The case for more stimulus was underlined by data showing retail sales were surprisingly soft in the March quarter, falling 0.1 percent when adjusted for inflation.

That posed a downside risk to economic growth in the quarter and offset another strong reading on international trade.

Australia's trade surplus for March beat expectations at A$4.9 billion ($3.43 billion) and set the seal on a record-breaking total of A$14.7 billion for the quarter.

The flood of cash might almost be enough to give the country a current account surplus, the first in modern history.

Across the Tasman Sea, the New Zealand dollar edged up to $0.6614, but was still close to recent lows of $0.6581.

Both it and the Aussie had taken a hit on Monday after U.S. President Donald Trump's threats of more tariffs on China threatened to derail chances of a trade deal anytime soon and sent stock markets sliding.

The Reserve Bank of New Zealand (RBNZ) holds its policy meeting on Wednesday and again markets are unsure if it will cut rates or hang on for a while longer.