A 25-BASIS-POINT rate cut would boost financial stocks and retailers and dent the Australian dollar, but market analysts warn a 50-basis-point cut next week could send a worrying signal in the run-up to the federal budget.
The sharemarket closed higher and the dollar dropped yesterday on surprisingly weak inflation data interpreted as making a May rate cut a fait accompli.
Economist Saul Eslake said calls from retailers and housing bodies for a bumper 50-basis-point cut at Tuesday's Reserve Bank meeting would "encourage speculation in the market that there was something really horrible in the budget coming".
"I don't think that's the kind of message it wants to send," said Mr Eslake, chief economist at Bank of America-Merrill Lynch Australia.
Joseph Capurso, currency strategist at Commonwealth Bank, said a 25-basis-point cut was the "right response to that low inflation number and to good, but not great, economic growth".
"The economy is not heading into recession nobody is suggesting the economy is heading into recession," Mr Capurso said.
"For the RBA to start cutting by 50, you'd have to have that sort of dire forecast, rather than just a slowdown." Mr Capurso said if the RBA cut by 25 points in May, the Australia dollar would probably immediately rise US0.3? or US0.4?. For 50 basis points, the local call was a rise of US0.7? or US0.8?.
But Peter Esho, chief market analyst at City Index, said a 50-basis-point cut held some appeal, beyond lifting the sharemarket, particularly retailers and banks.
"Inflation is now running below their target band," Mr Esho said. "And the last time they did two 25-basis-point cuts, the banks repriced according to their own terms, and it didn't necessarily have an immediate impact on the market.
"And even if they move by 50, they still have room to move later in the year should the situation in Europe deteriorate," he said.
Alex Moffatt, director at stockbrokers Joseph Palmer & Sons, said there was only a 60 per cent chance of a rate cut next week, arguing the Reserve Bank would be keen to preserve its buffer should the global economy sour again. "I think the market would probably welcome a rate cut, and certainly there's comment that interest rates are stifling manufacturing, but really it's the commercial banks that are setting interest rates, not the Reserve Bank," he said.
Russell Zimmerman, executive director of the Australian Retailers Association, said a 50-point rate cut would provide an antidote to an "ordinary" start to 2012 for retailers.
"Retailers are struggling to the point where it's going to cause more people to restructure their business. It will cost jobs in the future if we don't see relief," Mr Zimmerman said.
The Housing Industry Association is calling for 75 points to be shaved from the official cash rate, but chief economist Harley Dale said 50 points would put a floor under deteriorating conditions.
Mr Eslake is doubtful about a rate cut's likely impact on consumer sentiment.
"I wouldn't overstate it. People will be inclined to save much of the benefits of lower interest rates. But nonetheless knowing that they're paying their mortgages down may be helpful," he said.