Australia's central bank cuts rates for the first time in more than four years, flags economic uncertainties

The Reserve Bank of Australia on Tuesday cut benchmark interest rates for the first time in over four years, finally joining ranks with other major global central banks, as softening inflation allows room for easing policy.

The RBA cut rates by 25 basis points to 4.10%, marking its first easing since November 2020, when the central bank cut its key rate to a record low, as it battled a slowing economy during the pandemic.

"While today's policy decision recognises the welcome progress on inflation, the Board remains cautious on prospects for further policy easing," the RBA board members said in the statement.

The statement signaled the central bank's intention to keep "any further withdrawal of monetary restriction" gradual, Abhijit Surya, senior APAC economist at Capital Economics said in a note.

As the RBA sounded a hawkish tone, Surya forecast the ongoing easing cycle to be "short-lived," penciling in only two rate cuts in the current cycle, pegging the terminal cash rate at 3.60%.

The central bank had held its policy rate steady at 4.35% since November 2023, following an extended period of 13 rate hikes to tame inflation.

The Tuesday decision was in line with market expectations, with government bonds rallying in recent weeks on anticipation of an interest rate cut. The yields on Australian 10-year government bonds dropped nearly 20 basis points since Jan. 13 to 4.450% on Tuesday, according to LSEG data.

The RBA has lagged behind major global central banks that kicked off an easing cycle late last year.

In its last policy meeting in December, the central bank said it was more confident that inflation was declining and that might allow it to ease policy at some stage.

Australia's inflation over the 12 months through the December quarter eased to 2.4%, compared with 2.8% in the 12 months through September quarter, the Australian Bureau of Statistics data showed. The RBA has pegged its medium term inflation target between 2% and 3%.

The inflationary pressure is "easing a little more quickly than expected," RBA said Tuesday, noting that it has gained confidence that inflation was heading "sustainably" towards the midpoint of its target range.

One factor that has been holding back the cash rate's descent has been the strength of the labor market, with unemployment rate hovering near a historic low level of 4.0% in December. "Some recent labour market data have been unexpectedly strong, suggesting that the labour market may be somewhat tighter than previously thought," RBA said.

The cut in borrowing costs will be a shot in the arm for the Labor government as it prepares for a tough election this year, amid sluggish economic growth.

The country's seasonally adjusted gross domestic product rose 0.3% in the September quarter, while annual growth slowed to 0.8%, from 1.0% in the previous quarter, the lowest rate since the pandemic.

"There are notable uncertainties about the outlook for domestic economic activity and inflation. The central projection is for growth in household consumption to increase as income growth rises. But there is a risk that any pick-up in consumption is slower than expected," RBA said in its Tuesday statement.

The Australian dollar strengthened slightly to 0.6341 against the U.S. dollar. The ASX 200 index extended losses on Tuesday, shedding 0.54%.