Reserve Bank of Australia Cuts Rates to Record Low

Reserve Bank of Australia (RBA) headquarters in Sydney, Australia
Ian Waldie | Bloomberg | Getty Images
Reserve Bank of Australia (RBA) headquarters in Sydney, Australia

Australia's central bank cut its key interest rate by 25 basis points on Tuesday to a record low of 2.75 percent to boost economic growth, in a move that surprised many analysts and knocked the Aussie dollar to its lowest level in just over a month.

Most economists had expected the central bank to leave interest rates steady given signs of a pick-up in growth.

However, softer-than-expected inflation data last month and signs of weakness in China's economy, Australia's biggest trading partner, had sparked some talk in markets of a rate cut this month.

(Read More: China's PMI Miss: Is It Downhill From Here? )

"I was a bit surprised by the rate decision and the market was about 50-50 on the chances of a cut," said Matthew Circosta, an economist at Moody's Analytics in Sydney. "But they [the central bank] have said that there was a bias towards further easing."

The Reserve Bank of Australia (RBA) has now slashed interest rates 200 basis points since late 2011 to boost the economy. Tuesday's rate cut was the first move since the central bank eased monetary policy in December.

The RBA is the latest central bank to step up efforts to support growth. Last week, both the European Central Bank and Reserve Bank of India cut interest rates by a quarter point.

In a statement, the Australian central bank said that a peak in resource investment was likely to occur this year and that there was scope for other areas of the economy to strengthen.

This view probably explains why the central bank has eased monetary policy again, to bolster the non-mining sectors of the economy, analysts said.

"The RBA says it wants to encourage sustainable growth; it wants to boost the non-mining sectors of the economy as mining investment peaks," Circosta added.

Australia's benchmark stock index trimmed its losses following the rate cut to trade at around 5,154 points, not too far away from a 4-1/2 year high touched on Monday.

Aussie Tumbles

The Australian dollar fell to $1.0175, its lowest level in just over a month and down 0.6 percent from where it traded just before the RBA's rate decision.

"The RBA went earlier than many had expected so we are seeing a move in the Aussie," said Mitul Kotecha, head of global currency strategy at Credit Agricole. "But I don't think we will see a massive sell-off in the Aussie dollar."

The Aussie dollar had come under selling pressure on talk that billionaire investor George Soros was planning to take a short position on the currency.

(Read More: Soros Rumors Show Tide Turning Against Aussie )

Analysts said that even with Australian interest rates at a record low, they remain well above rates in other developed countries and that meant the so-called rate differential should continue to lend the Aussie dollar some support.

(Read More: Watch Out Euro Bulls, Draghi Is Watching You)

Interest rates in the U.S. and Japan for instance are at or near zero, while the key rate in the euro zone is just 0.5 percent and talk of negative interest rates in that region is starting to grow.

Run of Rate Cuts?

Opera House in Sydney, Australia.
Maisant Ludovic | | Getty Images

In its statement, the RBA suggested there was room to ease monetary policy further because inflation was subdued and the Australian dollar, relatively strong.

Data last month showed headline inflation accelerated just 0.4 percent in the first quarter, well below market expectations for a 0.7 percent increase.

The central bank may well cut interest rates again but the scope for monetary easing beyond that was limited, according to analysts.

"I don't think this will be the start of a run of rate cuts. They [RBA officials] will be happy with this move," said Kotecha.

Clifford Bennett, chief economist, at the White Crane Group in Sydney, said he expected one further rate cut from the RBA.

"The RBA may cut rates one more time to 2.50 percent, but expect rates to bottom here at 2.75 percent, or at 2.50 percent, and then to remain stable until after the federal election [in September]," he said in a research note.

"The long term outlook is for rates to remain below 4 percent over the next 3-4 years, to support a difficult domestic recovery phase," Bennett said.

- By CNBC.Com's Dhara Ranasinghe, Follow her on Twitter: @DharaCNBC