The decision surprised a number of prominent economists that had forecast the Reserve Bank of Australia (RBA) to cut rates to 1.25% this month.
Of the 26 economists polled by Bloomberg, 14 expected a cash rate cut.
Financial markets had placed the probability of a rate cut at 47%.
There has been no rate change since August 2016, when the RBA cut rates by 25 basis points from 1.75%.
RBA: Further labour market improvement needed
Calls for the RBA to cut rates this month were sparked by the drastically-low March quarter inflation reading of 0% which took Australia’s annual rate to 1.3% – well below the RBA’s target band of between 2-3%.
But surprisingly-strong employment figures released in the week prior to the inflation reading appears to have kept the central bank from cutting.
The RBA had made it clear in mid-April that it would consider cutting rates should the unemployment rate rise without rising inflation.
So while inflation is far from rising at the moment, the unemployment rate is holding strong.
In his accompanying monetary policy statement, RBA Governor Philip Lowe said the board would be paying close attention to labour market developments in its upcoming meetings.
“The Board judged that it was appropriate to hold the stance of policy unchanged at this meeting. In doing so, it recognised that there was still spare capacity in the economy and that a further improvement in the labour market was likely to be needed for inflation to be consistent with the target,” Mr Lowe said.
Earlier in the statement, Mr Lowe said acknowledged Australia’s strong labour market.
“The unemployment rate has been broadly steady at around 5 per cent over [the past six months] and is expected to remain around this level over the next year or so, before declining a little to 4¾ per cent in 2021,” he said.
“The strong employment growth over the past year or so has led to some pick-up in wages growth, which is a welcome development.”
Cash rate cut likelihood “remains high”
Tim Lawless, head of research at property data firm CoreLogic, said while current low inflation wasn’t enough to drag interest rates lower, the likelihood of a cash rate cut over the coming months remains high.
“If the cash rate does move lower later this year, a reduction in mortgage rates would provide some support for housing demand, however we may not see quite as much stimulus for housing market conditions that we have seen after previous rate cuts,” Mr Lawless said.
“Households who already have a mortgage, or prospective borrowers who are able to satisfy lender credit policies will be the winners if interest rates do fall later this year.”
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