The Reserve Bank of Australia has slashed the cash rate by 0.25 per cent to a new historic low of 1.75 per cent, 12 months since the last rate cut.

The surprising news came just five hours before the 2016 federal budget will be handed down.

It follows days of speculation regarding a rate cut, fuelled by the release of inflation data last week, which revealed that Australia’s Consumer Price Index (CPI) has dramatically shrunk.

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Lending standards have been tightened, particularly for property. Photo: AAP

Key to the decision was the reading of core inflation — the RBA’s preferred measure — at 1.5 per cent, the lowest reading on record and well below the target band of 2 to 3 per cent.

If the 25 basis point cut was fully passed on to home loans by the banks, it would equate to a $43-a-month saving on a typical 25-year $300,000 mortgage.

Reserve Bank governor cited last week’s inflation number as the main reason for the decision.

“Inflation has been quite low for some time and recent data were unexpectedly low,” Mr Stevens said in a statement.

“While the quarterly data contain some temporary factors, these results, together with ongoing very subdued growth in labour costs and very low cost pressures elsewhere in the world, point to a lower outlook for inflation than previously forecast.

“In reaching today’s decision, the Board took careful note of developments in the housing market, where indications are that the effects of supervisory measures are strengthening lending standards and that price pressures have tended to abate. At present, the potential risks of lower interest rates in this area are less than they were a year ago,” he said.

National Australia Bank is cutting its variable mortgage rates by 0.25 percentage points, passing on the Reserve Bank’s rate cut in full.

The big four banks have attracted criticism for not passing on in full previous rate cuts, and there has been uncertainty about whether any cut would flow through this time due to the banks’ need to raise additional capital through product repricing.

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Only one economist, Savanth Sebastian of CommSec, correctly predicted the rate cut, with low inflation a likely key factor influencing the decision, he said.

Money Expert at finder.com.au, Bessie Hassan, said the new cash rate could pave the way for further savings, if you’re willing to do your homework.

“Our new cash rate of 1.75 per cent is remarkable – it is the lowest it’s ever been and a far cry from the pre-GFC days of circa 7 per cent,” Ms Hassan said.

“The purpose of monetary policy is to keep inflation between 2-3 per cent and any data showing inflation below target immediately leads to speculation of a rate movement, as has been witnessed over the past week.

“This afternoon’s decision ended 12 consecutive months of rate stability from the Reserve Bank, but borrowers may enjoy the significant benefits that can result from a rate cut – should their lender pass it on in full.”

Political reaction

Prime Minister Malcolm Turnbull has cited the Reserve Bank’s decision to cut the official interest rate as support for his government’s plan to transition the economy from the mining boom.

Mr Turnbull read from Governor Glenn Stevens’ reasons for an historic 25-basis-point reduction during question time, just hours before the release of the federal budget.

“The governor’s remarks underline the risk posed by the opposition to that successful transition (from the mining-construction boom),” he said on Tuesday.

Labor believes the decision to cut the rate from 2.5 per cent to 1.75 per cent is a reflection of the government’s poor economic management.

“So while low interest rates are welcome, now is not the most exciting time for hard working Australians who can’t get a decent wage rise and can’t afford a house,” shadow treasurer Chris Bowen said in a statement.

He cited previous claims by the coalition that a rate of 2.5 per cent was a sign of economic weakness.

– with ABC