The Reserve Bank of Australia (RBA), which last cut its rate one year ago, said the subdued growth in labour costs and very low cost pressures around the world point to a lower outlook for inflation that previously forecast.
Australia's headline inflation rate declined to 1.3 percent the first quarter of this year from 1.7 percent in the final 2015 quarter, immediately triggering speculation in financial markets that the RBA could cut rates today.
Last month the RBA had flagged that it could cut its rate if inflation didn't start to pick up, saying continued low inflation would provide scope for easier policy to lend support to demand.
In contrast, the RBA did not issue a guidance about its future policy decisions today, a likely sign that it will maintain rates in coming months.
RBA Governor Glenn Stevens said the bank's monetary policy had been accommodative for some time and low interest rate had helped support demand and the lower exchange rate of the Australian dollar had helped economic activity.
But Stevens added that "an appreciating exchange rate could complicate this," echoing his statement from last month that the central bank would be concerned about a rising exchange rate.
"In Australia, the available information suggests that the economy is continuing to rebalance following the mining investment boom," Stevens said, growth should continue this year though probably at a more moderate pace than in 2015.
The RBA said it had taken "careful note of developments in the housing market," as part of its decision to cut the rate, but there are signs prices pressures are easing due to supervisory measures and the "potential risks of lower interest rates in this area are less than they were a year ago."
"Taking all these considerations into account, the Board judged that prospects for sustainable growth the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting," Stevens said.
The core inflation rate in the first quarter of this year fell to 1.67 percent from 2.15 percent in the last quarter of 2015. The RBA targets inflation of 2 - 3 percent.
Australia's economy expanded by an annual rate of 3.0 percent in the last quarter of 2015, up from 2.7 percent in the third quarter.
After depreciating against the U.S. dollar since September 2014, the Australian dollar - known as the Aussie - has been rising since mid-January on the back of higher iron ore prices. Just over half of the world's iron ore exports come from Australia.
The slowdown in China's economy dented demand for Australian commodities and in 2015 the Aussie lost 11 percent against the dollar.
In response to the rate cut, the Aussie fell sharply to 1.323 to the dollar from 1.297 before the news, but it is still up 3.5 percent since the beginning of this year.
The Reserve Bank of Australia issued the following statement:
"At its meeting today, the Board decided to lower the cash rate by 25 basis points to 1.75 per cent, effective 4 May 2016. This follows information showing inflationary pressures are lower than expected.
The global economy is continuing to grow, though at a slightly lower pace than earlier expected, with forecasts having been revised down a little further recently. While several advanced economies have recorded improved conditions over the past year, conditions have become more difficult for a number of emerging market economies. China's growth rate moderated further in the first part of the year, though recent actions by Chinese policymakers are supporting the near-term outlook.
Commodity prices have firmed noticeably from recent lows, but this follows very substantial declines over the past couple of years. Australia's terms of trade remain much lower than they had been in recent years.
Sentiment in financial markets has improved, after a period of heightened volatility early in the year. However, uncertainty about the global economic outlook and policy settings among the major jurisdictions continues. Funding costs for high-quality borrowers remain very low and, globally, monetary policy remains remarkably accommodative.
In Australia, the available information suggests that the economy is continuing to rebalance following the mining investment boom. GDP growth picked up over 2015, particularly in the second half of the year, and the labour market improved. Indications are that growth is continuing in 2016, though probably at a more moderate pace. Labour market indicators have been more mixed of late.
Inflation has been quite low for some time and recent data were unexpectedly low. 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.
Monetary policy has been accommodative for quite some time. Low interest rates have been supporting demand and the lower exchange rate overall has helped the traded sector. Credit growth to households continues at a moderate pace, while that to businesses has picked up over the past year or so. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this.
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.
Taking all these considerations into account, the Board judged that prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting."