The Reserve Bank of Australia (RBA) lowered its key interest rate by 25 basis points on Tuesday, bringing it to a two-year low of 3.85%, due to a weakening global economic outlook and moderating domestic inflation.

However, it signalled a cautious approach toward any further rate cuts.

In response, the Australian Dollar dropped 0.4% to $0.6430, while three-year bond futures rose by 5 ticks to 96.40. Market pricing in interest rate swaps suggests a total rate reduction of 57 basis points by year’s end.

Following its two-day policy meeting, the central bank noted that inflationary pressures had eased and that global trends were likely to dampen the national economy.

Markets had already fully anticipated a rate cut, driven by a domestic slowdown in inflation and a gloomier global outlook, particularly after last month’s announcement of steep US tariffs on imports, Reuters reports.

“Inflation is in the target band and upside risks appear to have diminished as international developments are expected to weigh on the economy,” according to a statement by the board.

“The board assesses that this move will make monetary policy somewhat less restrictive. It nevertheless remains cautious about the outlook.”

Headline consumer price inflation remained steady at 2.4% in the first quarter, while the trimmed mean measure of core inflation eased to 2.9%, bringing it within the RBA’s 2% to 3% target range for the first time since late 2021.

“The bank continues to strike a cautious tone about further rate cuts, noting that weak productivity growth and the tight labour market continue to put upward pressure on labour costs,” stated Sean Langcake, head of macroeconomic forecasting for Oxford Economics Australia.

Moreover, wages growth accelerated in Q1, primarily driven by government pay increases, but the central bank noted this was unlikely to trigger a harmful wage-price spiral.

In its quarterly Statement on Monetary Policy released on Tuesday, the RBA also projected lower inflation and higher unemployment, attributing this to the ripple effects of escalating global trade tensions, even under the assumption that interest rates would be cut as significantly as markets anticipate.

The RBA cautioned that the impact of President Trump's tariffs would dampen global economic growth and ultimately have a disinflationary effect on the Australian economy.