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It would probably come as no surprise if the Reserve Bank of Australia (RBA) decides to slash interest rates during its rate decision tomorrow as all signs point to further easing from the central bank.

To begin with, recent economic figures show that the Australian economy is in dire need of a boost. The retail sales report, which printed a mere 0.2% uptick in February, revealed that consumer spending is still subdued as Australians are concerned about slow job growth.

Key components of the report also showed that households are putting a larger chunk of their income in savings instead of making more purchases.

Aside from that, the housing sector seems to be on shaky ground as building approvals turned out to be a huge disappointment (the February figure slipped to its lowest reading in nearly three years).

With the report chalking up close to an 8% decline over the past three months, analysts are worried that housing activity could slump below global financial crisis levels. Yikes!

Those are just some of the many reasons why the Australian economy could use further easing. For one thing, lower interest rates could keep the Aussie’s gains in check, which could help Australian companies stay competitive in terms of international trade. After all, non-mining industries such as manufacturing and tourism are currently battling with wage increases and energy price hikes, and are struggling to stay afloat.

A rate cut from the RBA could also spur business confidence, which could use some support as companies will face additional headwinds in the coming months. Bear in mind that the new law on a carbon tax, higher penalty rates, and award wages are set to be implemented in July this year, which would mean additional costs for businesses.

But perhaps the biggest sign that the RBA will cut rates is the recent quarterly inflation report, which showed a measly 0.1% CPI reading for the first quarter of the year. Based on the minutes of their previous monetary policy meeting, RBA policymakers were keeping a close eye on inflation figures to see whether they have room to cut rates or not.

Obviously, the case for a rate cut is very strong. But how can knowing all of this help us in our trading? Well, let’s take a look at three potential scenarios for the upcoming rate statement and how they could play out on the charts:

  1. RBA cuts rates by 0.25% This is widely considered the most likely scenario as most analysts and economists see the RBA slashing interest rates from 4.25% to 4.00%. The immediate market reaction to a 0.25% rate cut will likely be a sharp Australian dollar (AUD) sell-off, but the move might be limited as price action in recent weeks suggests the markets may have already priced in a 0.25% cut.
  2. RBA cuts rates by 0.50%We can’t discount the possibility of a 0.50% cut, my friends! Though it has been a while since the RBA last slashed interest rates by more than 0.25% at a rate statement, it isn’t a stranger to aggressive easing. Recall that in late 2008, it began a series of cuts that took the central bank’s interest rates from 7.25% to 3.25% in just 6 months.In this old man’s opinion, cutting interest rates from 4.25% to 3.75% will likely result in a big, extended drop, as the need for a 0.50% rate cut would suggest a very weak economy.
  3. No rate cut, RBA keeps rates at 4.25%This is probably the least likely and least expected scenario, as market players seem convinced that we’ll see a rate cut of some sort. If the RBA fails to deliver a rate cut, it would be a major disappointment to investors, some of whom have been waiting for a rate cut since February. Hence, we could see a surge in the AUD as it erases some of its recent losses.

Interest rates aside, AUD price action in the medium and long-term will also depend heavily on how the RBA addresses future policy. For instance, we could see strong bearishness for the AUD if the RBA drops hints that it will continue easing monetary policy over the coming months, so it’s important to read between the lines and listen closely for clues in the accompanying statement.

In any case, you won’t have to wait for long because the RBA rate decision is due in less than 24 hours! Catch this potentially explosive event tomorrow morning (Tuesday, May 1, 2012) at 4:30 am GMT.