The Reserve Bank has taken decisive steps to take the heat out of the high Australian dollar by cutting the cash rate to its lowest level in more than half a century.
The central bank eased interest rates by 25 basis points to 2.75 per cent on Tuesday, the first reduction this year. The easing cycle has given rise to cuts of 200 basis points since November 2011, bringing the cash rate below the emergency settings of the global financial crisis.
It is also the first time the RBA has cut interest rates to below 3 per cent since it began setting monetary policy in 1990.
RBA governor Glenn Stevens said low inflation gave the board the scope to ease rates to support demand, adding that a "further decline in the cash rate was appropriate to encourage sustainable growth in the economy".
"The RBA appears to have simply grown weary of a high Australian dollar, while becoming more comfortable about the high pace of domestic inflation given the improving productivity trend," UBS economists Scott Haslem and George Tharenou said.
The Australian dollar lost half a cent after the decision, falling to as low as US101.78¢ before stabilising just below US102¢ about 5pm on Tuesday. Three of the four big banks passed on the full cut, with ANZ to make a decision on Friday as part of its monthly review.
The RBA decision came after a spate of soft economic data, which has called into question the strength of the housing recovery, while pointing to a rising unemployment rate, continued weakness in the manufacturing sector and slow private credit sector growth.
ANZ strategist Andrew Salter said the Reserve was not targeting the currency directly, but seeking to support sectors battling the stubbornly strong dollar. "We've had indications in some of the economic data that the currency is having a contractionary impact and what the RBA is doing is reducing cash rates to offset that," he said.
The RBA's board members signalled in previous statements and speeches their concern about the high dollar despite the decline in export prices and interest rates.
Tuesday's statement put forward a stronger position, with Mr Stevens pointing out that the exchange rate "has been little changed at a historically high level over the past 18 months".
"It appears that [the Australian dollar] was a key motivation for today's cut," HSBC chief economist for Australia Paul Bloxham said, adding their currency worries had gone "beyond jawboning".
The central bank had stopped short of directly stepping in to influence the currency.
Australia is one of the few countries with a AAA rating, making the country more attractive to global funds looking for investment havens. At the same time, its cash rate is the highest among developed countries despite being at historic lows domestically.
Quantitative easing measures by central banks have also depressed yields overseas, making the Australian currency more appealing to global investors. Yet while the Reserve Bank retained an easing bias in Tuesday's statement and added it had used only "some of that scope" from low inflation to ease rates, economists said they did not expect another cut for a few months.
They said the cash rate was likely to remain lower for a longer period compared with previous easing cycles, given the dollar's strength, low commodity prices and slowing growth in China.
"I think right now, they would expect to be on hold for the next few months as they wait for more information," UBS strategist Matthew Johnson said.