SYDNEY (Reuters) - Australian markets have rushed to narrow the odds on a near-term cut in interest rates following a surprise easing from Canada, not least because of the similarities between the two countries as major commodity exporters.
Interbank futures on Thursday implied a one-in-three chance of a quarter-point cut in the 2.5 percent cash rate next month, up from a mere one-in-20 just days ago.
The market is now fully priced for a move by April and a total cut of nearly 50 basis points over the next 12 months.
Yields on benchmark 10-year Australian government bonds have shrunk to where they are only a few basis points above the overnight rate.
While Canada has been hit by a slump in oil prices, a point the Bank of Canada used to justify its 25 basis point cut, Australia has been whacked by a collapse in the value of iron ore, its biggest export, amid weakness in its key market China.
"When considering the peak to trough move in key commodity prices since 2010, the fall in oil is actually matched by the decline seen in iron ore - around 65 percent," said Daniel Been, senior FX strategist at ANZ.
"Should next week's business confidence and inflation numbers look as soft as we anticipate, a more sustained RBA easing cycle will be priced, and the AUD will break through 80 U.S. cents."
A lower exchange rate would come as a relief for an economy facing a steep drop in crucial mining investment, while confidence in other sectors remains stubbornly soft.
The Australian dollar has already sunk to $0.8072, and near a six-year trough of $0.8033, as investors bet the Reserve Bank of Australia (RBA) will follow the Bank of Canada's move.
Canada's easing followed close on moves in Denmark, Turkey, Switzerland and India and knocked the Canadian dollar to a six-year low, raising the heat in a global currency war.
The euro has already slumped to an 11-year low as the European Central Bank is expected to launch a large-scale sovereign bond buying program later on Thursday.
While the RBA does not specifically target foreign exchange rates when setting policy, it might conclude that it has to follow the pack and cut just to stop the currency from rising.
Last month, RBA governor Glenn Stevens said an exchange rate closer to 75 U.S. cents was more appropriate for the economy.
Reporting by Ian Chua; Editing by Nachum Kaplan & Kim Coghill