Finance sector expectation is growing that the Reserve Bank board will further reduce the overnight cash rate from 3.75 percent to 3.50pc when it meets tomorrow (Tuesday), with the prospect of further interest rate cuts in July and August.

Providing commentary on Friday, Westpac chief economist Bill Evans said his bank now expected that the low-point in the current easing interest rate cycle will be 2.75pc rather than the 3.25pc which it had predicted earlier.

“We anticipate further RBA cuts in July and August to be followed by a final cut in the fourth quarter,” Mr Evans said.

However Westpac did not support the likelihood of an 0.5pc cut on Tuesday.

“The decision to cut by 50bps in May was mainly driven by direct concerns around the domestic economy. To us, there appeared to be an element of catch-up, with the RBA holding steady in February–April when the domestic case for a cut was strong,” Mr Evans said.

The decision tomorrow would be built around the impact that the deterioration in global confidence will have on the Australian economy. Since the Board meeting in May, US ten-year bond rates were down from 1.9pc to 1.6pc and the Australian equivalent was down from 3.6pc to 2.9pc.

“However, there are a number of key risk events over the next few weeks, including Greek elections on June 17, which will be critical for global confidence. We expect a more orderly approach to addressing these issues and thus a more ‘considered’ 0.25pc move,” Mr Evans told the market.

However nobody could be particularly confident in gauging the RBA’s meeting-by-meeting strategy for dealing with interest rate issues.

Westpac’s expectation of two extra cuts before December is based on its assessment that the global environment – principally, Europe – has deteriorated even further since it revised downwards its earlier call for the low-point from 3.75pc to 3.25pc. In turn this deterioration is expected to have a more severe impact on confidence in Australia than had earlier been expected.

Market pricing is reflecting extreme uncertainty, and it is distorted by hedging activity by offshore investors who are not taking a pure position on Australian monetary policy, and it is therefore highly volatile. This uncertainty comes from:

• The European outlook, highlighted by the risk of Greece withdrawing from the Euro and excessive instability in the Spanish banking/sovereign nexus.
• The state of the Chinese economy and prospects for countercyclical policies to be enacted and to gain traction.
• Prospects for the US economy where the recovery seems to be losing momentum
• The impact on private sector rates in Australia of official rate cuts and the spill-over to confidence.
• The state of the labour market in Australia following the surprise fall in the unemployment rate from 5.2pc to 4.9pc.
• Prospects for the interest rate sensitive parts of the Australian economy – housing and consumer expenditure and the investment and employment decisions of those firms which service those sectors.

Mr Evans said his forecasts were based around a general outlook that while Greece was unlikely to leave the Euro, the European ‘scene’ would be marked by rolling crises and bailout packages against a back drop of protracted recession in the region. That would avoid the worst-case scenario that might be partly priced-in by the market but would ensure an ongoing drag on confidence, both consumer and business, in Australia.

“Recent news from Europe has reinforced our concerns for the region, particularly for Greece and Spain. For Greece, the June 17 election looms as a crucial event. The eventual outcome is highly uncertain,” he said.

Spain’s financial ill-health has also rapidly come back to the fore over the past month, primarily due to the need to fully nationalise banking conglomerate Bankia, formed in 2010 through the union of seven stressed regional banks. The need for a support package for Spain would be a serious test for the financial and political capital of the region. Westpac’s concern about the impact of these issues on confidence in Australia has increased in recent weeks.

Recent information out of China suggested that a recovery would get underway later this year, following policy adjustments which would get 2013 started on the front foot.

The US economy is likely to lose further momentum through the Northern spring and into summer. Deteriorating job and domestic demand growth are expected to result in another round of quantitative easing. Further weakness in equity and/or house prices would give further justification for action.

While offshore issues are likely to dominate the RBA’s explanation behind its decision on interest rates tomorrow, there was also a domestic case for lower rates.

While in the year to April, total employment across Australia lifted by 87,300 jobs, most of these were part-time. The fall in the unemployment rate has also been driven by the fall in participation rate.

Retail sales for April (down 0.2pc); spending on renovations and additions (down 4.7pc in the March quarter), residential building (down 1.9pc) and dwelling approvals have all been weak despite the rate cuts in November and December.

Outlook for the A$

Westpac says at present there are a number of downward pressures operating on the currency – rate differentials, commodity prices, the shift back into trade deficit and weak risk appetite globally – that will not dissipate in the short term.

“Therefore we feel that there is more to come in this depreciation phase,” Mr Evans said.

“We now see a 96¢ rate by the end of September, with a strong likelihood that it goes lower than that rate in the meantime. In the short-term, we expect the US$ index to show considerable strength, the yen's safe-haven status to shine through as Japanese investors exhibit strong home bias in a low yield world, while the euro will understandably find few adherents.”

“Asian currencies will also remain under pressure for the moment.”

“We do however retain the view that A$/US$ will be back above parity by year's end, in line with a pull-back in the USD index,” Mr Evans said.

“That call is largely predicated on an expected series of stimulus policies in Europe, China and the US that will gain traction, particularly through the December quarter. The combined effects will reverse the negative dynamics current swirling around the A$.”

Westpac sees the currency reaching US102c by the end of the year and moving even higher in early 2013, before levelling out at mid-year in the US105–106c area.