Forex trading: Australia’s dollar plunged after the country’s central bank unexpectedly cut interest rates amid fears of deflation and slowing growth.

The Reserve Bank of Australia (RBA) slashed its main cash rate by 25 basis points to a record low of 1.75%, citing inflation pressures that are “lower than expected”.

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RBA Outlook

 

RBA governor Glenn Stevens said that while the global economy is continuing to grow, it is doing so “at a slightly lower pace than earlier expected, with forecasts having been revised down a little further recently”.

He added: “Commodity prices have firmed noticeably from recent lows, but this follows very substantial declines over the past couple of years. Australia's terms of trade remain much lower than they had been in recent years.”

Inflation, or a lack of inflation, is the main concern. Official figures released just ahead of the meeting showed prices fell by 0.2% in the first quarter – the first deflationary pressures experienced since 2008.

“Inflation has been quite low for some time and recent data were unexpectedly low,” added Mr Stevens.

“While the quarterly data contain some temporary factors, these results, together with ongoing very subdued growth in labour costs and very low cost pressures elsewhere in the world, point to a lower outlook for inflation than previously forecast.”

The bank also noted difficult conditions in many emerging markets, with China in particular causing worries.

China Focus

 

“China's growth rate moderated further in the first part of the year, though recent actions by Chinese policymakers are supporting the near-term outlook,” said governor Stevens.

A private gauge of manufacturing activity in China contracted again in April, highlighting the risks to Australia’s resource-focused economy.

The Caixin-Markit manufacturing purchasing managers index dropped below the 50 mark in April, signalling another contraction in factory activity.

It dropped to 49.4 in April, which is down from 49.7 in March and points to worsening conditions for Chinese manufacturers.

“The fluctuations indicate the economy lacks a solid foundation for recovery and is still in the process of bottoming out. The government needs to keep a close watch on the risk of a further economic downturn,” commented Dr He Fan, chief economist at Caixin.

 

Aussie Slips

 

The decision had a predictable effect on the Australian dollar as it sank sharply on the news. The Aussie had already been under some pressure ahead of the meeting investors took the weak inflation figures as a dovish signal.

Despite the slide, AUD is still trading near to its best level in 11 months against its US counterpart.

In contrast, Australian stocks firmed up, rising 2% on the day of the announcement.

There is no lack of economic events for trading the Australian dollar over the next few days. Coming up this week are retail sales figures, trade balance data and the quarterly monetary policy statement from the RBA, which could offer some further insight into the bank’s appetite for any future rate cuts.