RBA to deliver first interest rate cut in years as inflation cools

The Reserve Bank of Australia is expected to cut the OCR by 25 basis points.
Australian core inflation eased in the final quarter of 2024 but remained above the RBA’s target.
The Australian Dollar consolidates gains against its American rival ahead of the announcement.

The Reserve Bank of Australia (RBA) will announce its first monetary policy decision of 2025 on Tuesday, and market participants anticipate the Board will cut the benchmark interest rate by 25 basis points (bps).

Since hiking the Official Cash Rate (OCR) to 4.35% in November 2023, the RBA has maintained it steady at this level, as inflation has remained stubbornly high. As a result, pressure on households and businesses has become a significant concern, with sluggish economic growth taking its toll on policymakers’ decisions.

Will this be the first of multiple interest rate cuts in Australia?

Indeed, inflation in Australia has given signs of improvement in December, boosting the odds for an interest rate cut in February.

The latest quarterly Consumer Price Index (CPI) released showed that inflation rose by less than anticipated in the final quarter of 2024. The RBA’s preferred inflation gauge, the Trimmed Mean CPI, was up 0.5% in the quarter, below the anticipated 0.6%, and the annualized figure hit 3.2%, down from the previous 3.5%.

Solid employment growth, on the other hand, weighs negatively on interest rate-cut odds. Annual employment growth strengthened to 3.1% in December from 2.3% in November, the strongest rate since October 2023. Australia is expected to have added 20K new jobs in January after creating 56,3K in December. January employment data, however, will not be available until after the RBA monetary policy announcement.

Back in December, the RBA’s decision accompanying the statement showed that “some of the upside risks to inflation appear to have eased and while the level of aggregate demand still appears to be above the economy’s supply capacity, that gap continues to close.”

However, the Minutes of the meeting released two weeks afterwards included a modest change in the wording. Officials were then “gaining some confidence” that inflation was moving sustainably towards their target of between 2% and 3%.

RBA Governor Michele Bullock also noted that the Board discussed that upside inflation risks had eased but not gone away, yet an interest rate cut or hike was not on the table.

Overall, market players anticipate a rate cut, but they do not expect it will be the first of many. On the contrary, the RBA is anticipated to maintain its cautious approach to monetary easing. The current restrictive policy settings would likely be unwound at a slow pace.

How will the Reserve Bank of Australia decision impact AUD/USD?

Should the RBA announce an expected 25 bps interest rate cut, the Australian Dollar (AUD) may come under selling pressure. However, how weak the AUD could be depends on what policymakers anticipate. If the Board announces an unexpected 50 bps trim or announces more cuts coming in the upcoming meetings, it would be quite bearish for the Aussie.

On the contrary, hints at spaced interest rate cuts may push the AUD up, as it would be read as a “hawkish cut.”

RBA Governor Michele Bullock will offer a press conference after the announcement and will have to explain much if the decision diverges from expectations.

Valeria Bednarik, Chief Analyst at FXStreet, says: “The AUD/USD pair peaked at 0.6373 ahead of the announcement, its highest since mid-December. The pair maintains its technically bullish stance amid broad US Dollar (USD) weakness. The Greenback trades on the back foot ever since financial markets understood US President Donald Trump’s fiscal measures pushed the Federal Reserve (Fed) into the hawkish path.”

“In fact, uncertainty over what US tariffs may mean to the Australian economy will likely be part of the RBA’s announcement,” Bednarik added.

“Technically speaking, the AUD/USD pair has scope to extend its advance towards the 0.6470 region, where the pair presents multiple intraday highs and lows from the last few months. To reach such an altitude, the pair first needs to overcome the aforementioned intraday high, which is the immediate resistance level. Interim resistance comes next at 0.6430. A dovish outcome could push the pair through the 0.6300 threshold, with additional slides exposing the 0.6230 price zone.”

Australian Dollar FAQs

One of the most significant factors for the Australian Dollar (AUD) is the level of interest rates set by the Reserve Bank of Australia (RBA). Because Australia is a resource-rich country another key driver is the price of its biggest export, Iron Ore. The health of the Chinese economy, its largest trading partner, is a factor, as well as inflation in Australia, its growth rate and Trade Balance. Market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – is also a factor, with risk-on positive for AUD.

The Reserve Bank of Australia (RBA) influences the Australian Dollar (AUD) by setting the level of interest rates that Australian banks can lend to each other. This influences the level of interest rates in the economy as a whole. The main goal of the RBA is to maintain a stable inflation rate of 2-3% by adjusting interest rates up or down. Relatively high interest rates compared to other major central banks support the AUD, and the opposite for relatively low. The RBA can also use quantitative easing and tightening to influence credit conditions, with the former AUD-negative and the latter AUD-positive.

China is Australia’s largest trading partner so the health of the Chinese economy is a major influence on the value of the Australian Dollar (AUD). When the Chinese economy is doing well it purchases more raw materials, goods and services from Australia, lifting demand for the AUD, and pushing up its value. The opposite is the case when the Chinese economy is not growing as fast as expected. Positive or negative surprises in Chinese growth data, therefore, often have a direct impact on the Australian Dollar and its pairs.

Iron Ore is Australia’s largest export, accounting for $118 billion a year according to data from 2021, with China as its primary destination. The price of Iron Ore, therefore, can be a driver of the Australian Dollar. Generally, if the price of Iron Ore rises, AUD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Iron Ore falls. Higher Iron Ore prices also tend to result in a greater likelihood of a positive Trade Balance for Australia, which is also positive of the AUD.

The Trade Balance, which is the difference between what a country earns from its exports versus what it pays for its imports, is another factor that can influence the value of the Australian Dollar. If Australia produces highly sought after exports, then its currency will gain in value purely from the surplus demand created from foreign buyers seeking to purchase its exports versus what it spends to purchase imports. Therefore, a positive net Trade Balance strengthens the AUD, with the opposite effect if the Trade Balance is negative.

Economic Indicator

RBA Press Conference

Following the Reserve Bank of Australia’s (RBA) economic policy decision, the Governor delivers a press conference explaining the monetary policy decision. The usual format is a roughly one-hour presser starting with prepared remarks and then opening to questions from the press. Hawkish comments tend to boost the Australian Dollar (AUD), while on the opposite, a dovish message tends to weaken it.