(Bloomberg) -- Australia’s central bank signaled a pause in its 10-month tightening cycle is in prospect, prompting a selloff in the currency after policymakers delivered an expected interest-rate increase on Tuesday.

The Reserve Bank lifted its cash rate by a quarter-percentage point to 3.6%, the highest level since May 2012. Governor Philip Lowe said in his statement that in assessing “when and how much further” rates need to go up, the RBA will pay close attention to incoming economic data.

“The reference to assessing ‘when’ means that the RBA board has not yet made their mind up around increasing the cash rate in April,” said Gareth Aird, head of Australia economics at Commonwealth Bank of Australia. “Markets should treat the April Board meeting as ‘live’ and the RBA could pause.”

As investors positioned for a slowdown in the pace of future hikes, the Aussie dollar briefly fell below 67 US cents  and government bond yields declined. Traders pared bets on the RBA’s peak cash rate to 4% from a bit above 4.1%. 

Lowe’s signal moves him closer to the Bank of Korea, which has already stood pat, and the Bank of Canada, which is expected to do so Wednesday. It’s likely to put him at odds with Federal Reserve Chair Jerome Powell, who is grappling with sticky inflation and delivers a semi-annual monetary policy report to lawmakers this week.

Both the Fed and New Zealand’s central bank have increased borrowing costs by 4.5 percentage points in the current cycle, versus the RBA’s 3.5 points. 

Australia’s more cautious approach reflects its heavily indebted households, which are running down their savings in response to price increases and higher loan repayments. There are signs of rising mortgage stress and the latest corporate earnings guidance points to weakness ahead.

“I’d call it a dovish hike,” said Diana Mousina, senior economist at AMP Capital Markets. “They still have a tightening bias but my reading is that April will be a pause. By the time we reach May there will be enough data to suggest that the economy has slowed to not warrant further hikes.”

Already there are signs of a slowdown. Key readings through February missed expectations, with slower growth and inflation and higher unemployment suggesting the RBA’s tightening is beginning to have an impact.

“The monthly CPI indicator suggests that inflation has peaked,” Lowe said Tuesday. “Recent data suggest a lower risk of a cycle in which prices and wages chase one another.” 

What Bloomberg Economics Says...

“We see slowing demand, a weakening labor market and peaking inflation eventually driving the RBA to go on hold after its May meeting.”

— James McIntyre, economist. 

For the full note, click here

Lowe highlighted that policy operates with a lag and that the full effect of the hikes to date is yet to be felt. He added that the timing and extent of a slowdown in household spending remains a key uncertainty.

The more measured tone in the RBA’s statement underscores Lowe’s struggle to maintain a consistent message amid volatile macro data. Investors will now turn their attention to the governor’s speech on Wednesday morning, which is likely to flesh out his views. 

Australia’s clouded economic outlook has forced the nation’s center-left government to hold off on any significant new spending as it tries to keep fiscal and monetary policy aligned to slow inflation. Treasurer Jim Chalmers says his May budget will focus on “relief, repair and restraint.”

Australia’s fiscal position has been distorted by vast pandemic-era spending, with the nation’s budget deep in deficit even with unemployment near a 50-year low and commodity prices elevated.

“Today’s statement provides the RBA some optionality to pause the tightening cycle in the event that the recent weakness in the monthly labor force reports is sustained,” said Andrew Boak, chief Australia economist at Goldman Sachs Group Inc., who forecasts a terminal rate of 4.1%. 

“While possible, we expect a solid rebound in next week’s employment data.”

--With assistance from Tomoko Sato and Garfield Reynolds.

(Updates market reaction, adds comments from economists.)

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