Commentators are feverishly debating whether the Reserve Bank will cut the cash rate on Tuesday (February 3) in its most eagerly awaited rate announcement in almost two years.

• Inflation hits two-year low
• Will the Reserve Bank cut the cash rate?

The cash rate has been on hold at 2.5 per cent since a surprise cut in May 2013, but for the first time since then a number of commentators are predicting a rate cut to 2.25 per cent.

A lower cash rate would bring down mortgage rates.

More confusion was unleashed yesterday when the inflation figures showed that the consumer price index had increased by just 1.7 per cent in 2014, below the 2 per cent threshold the RBA targets. At face value this suggests consumers are spending less, which is bad for the economy.

However, the plummeting oil price probably makes the overall figure deceptively low.

The drop in inflation led some commentators to predict the RBA would cut the rate to stimulate more growth. In the Australian Financial Review today, for example, former trade minister Craig Emerson argued that a rate cut is needed now to help Australia transition out of the mining boom cycle. Other articles in the AFR today told a similar story.

However, AAP economist Garry Shilson-Josling argues that the RBA would not cut the cash rate as a “knee jerk reaction”, saying it would take a more nuanced look at how the Australian economy was doing.

The market generally agreed with Shilson-Josling, reading the inflation figures as better than expected. The ASX RBA Rate Indicator, which measures market sentiment, found just 18 per cent of the market expects a cash rate cut. This compared to 38 per cent the day before the Australian Bureau of Statistics announced the inflation figures.

All in all, the sentiment has clearly shifted in favour of cash rates staying on hold in February, with a rate cut more likely in March or April. However, economic conditions are extremely volatile, and all this could change before Glenn Stevens makes his announcement on Tuesday.