Economists left guessing on timing of RBA rate cut

It's the question dividing economists and financial markets ahead of the Reserve Bank's board meeting next week - to cut or not to cut?

The cash rate is at a historic low of 3 per cent, but some analysts said the central bank should continue its easing cycle, which has seen interest rates fall by 175 basis points since November 2011.

Financial markets are pricing in a 56 per cent chance the Reserve will reduce rates by 25 basis points on Tuesday. Markets are also pricing in that official cash rates could fall to at least 2.5 per cent by the end of the year.

At the same time, the majority of economists are taking a more cautious view and forecast June as the earliest month in which the RBA would make a move.

The strongest case supporting a cut is low inflation, said Macquarie economist Gabby Hajj, who supports lower rates.

"Abstracting from the impact that the carbon tax had on the inflation measure, inflation should be running at the bottom end of the target band. The RBA is an inflation-targeting central bank and lower inflation tends to indicate slowing growth and slowing demand," Mr Hajj said.

"In our view, it provides the scope and the catalyst for [the Reserve] to cut in May."

NAB senior economist David de Garis said there have been questions about the strength of the housing recovery, which the RBA has said is central to filling some of the gap expected to be left by the peak in mining investment later this year.

Another factor that could push the Reserve to lower rates is the higher unemployment rate, Mr Hajj said. While the Reserve expects unemployment to gradually tick up towards 5.75 per cent this year, the current level — 5.6 per cent — is already close to that.

In contrast, Barclays' chief economist Kieran Davies, who does not expect the Reserve to move on Tuesday, said it could point to improved activity in some sectors of the economy as a sign the earlier cuts were working.

"The housing market has picked up over the past year, house prices are off their lows of last year, consumer confidence is back above average and equity prices are also higher than last year," Mr Davies said.

He said the average interest rate for mortgages and households was already very close to the lows reached during the financial crisis when the economic situation was worse.

UBS chief economist Scott Haslem said some commodity prices, such as the iron ore price, had improved, pointing out that the iron ore price is currently between $130 to $140, compared to $100 when the Reserve last cut rates at the end of last year.

Mr De Garis said while the recent spate of economic data has been mostly disappointing, he expected the Reserve to wait until June before it makes a decision on whether to continue the easing cycle.

"[The Reserve] could at least argue that the case might be there to wait another month to see whether what we've seen in the past month is a bump along the way, and the recovery is still on track, or whether things have really flattened out, are receding again and the economy could take more stimulus," he said.