Australia, NZ dollars edge up, bonds celebrate RBA's dovish turn

By Wayne Cole

SYDNEY, May 21 (Reuters) - The Australian and New Zealand dollars regained some ground on Wednesday as economic worries undermined their U.S. counterpart, while bonds basked in the afterglow of a surprisingly dovish cut in domestic interest rates.

Markets have priced in an extra easing this year after the head of the Reserve Bank of Australia sounded much more relaxed about inflation after Tuesday's policy meeting, while revealing they had considered cutting by an outsized 50 basis points.

"The press conference marked a significant pivot away from the RBA's prior hawkish focus on a 'tight' labour market and upside risks to inflation," said Andrew Boak, an economist at Goldman Sachs.

"We now forecast sequential 25bp cuts in July and August followed by a final cut in November to a terminal rate of 3.1%. Our prior forecast was sequential cuts in July and August to terminal of 3.25%."

Markets now imply a better than 50% chance the RBA will cut again at its next meeting on July 8, up from less than 20% a week ago, while rates are now seen much more likely to bottom at 3.1% rather than 3.35%. 0#AUDIRPR

The shift initially pulled the Aussie down, but it edged up 0.3% on Wednesday against a broadly softer greenback to stand at $0.6442 AUD=D3 and away from support around $0.6390. Resistance lies around $0.6460 and $0.6500/6515.

The kiwi dollar inched up to $0.5940 NZD=D3, but remains corralled within a range of $0.5847 to $0.6029 that has held for the past month.

Bond markets cheered the RBA sea change and pushed three-year futures YTTc1 up to 96.530 from a low of 96.320 on Tuesday.

Yields on 10-year bonds were down at 4.429%, rallying from a four-month top of 4.583% touched last week. The spread to Treasuries also swung to minus 6 basis points, from plus 7 basis points a week before.

The RBA's dovish turn only encouraged investors to wager the Reserve Bank of New Zealand will cut its 3.5% cash rate at a policy meeting next week.

"We expect the RBNZ will deliver another 25bp rate cut, and also expect that they will signal the likelihood, or at least the chance, of some further reduction this year," said analyst at Westpac in a note.

Markets now imply rates reaching 2.83% by year-end, compared to 3.0% early in the week. 0#NZDIRPR