Contrary to expectations of an overnight cash rate cut, the Reserve Bank of Australia (RBA) kept on Tuesday the existing key lending rate at 4.25 per cent at the Monetary Committee's first policy rate meeting for 2012.

RBA Governor Glenn Stevens cited the inflation and economic growth being close to average after two interest rate reductions in late 2011 as the reasons behind the Australian central bank's decision to hold the benchmark rate.

"The board noted that interest rates have declined to be close to their medium term average as a result of the actions at the board's previous two meetings," Mr Stevens said in a statement.

"With growth expected to be close to trend and inflation close to target the budget judged that the setting of monetary policy was appropriate for the moment. Should demand conditions weaken materially the inflation outlook would provide scope for easier monetary policy. The board will continue to monitor information on economic and financial conditions and adjust the cash rate as necessary to foster sustainable growth," the governor explained.

Prior to the RBA announcement, the financial markets gave an 80 per cent chance of a 25 basis point cut.

The decision caused the Australian dollar to grow by 1 U.S. cent to $1.0789 which is the highest point since August. Had the RBA cut rates, the U.S. dollar would have weakened.

Stephen Koukoulas, managing director of Market Economics, said the financial market was surprised by the RBA decision.

"They were obviously very close to cutting interest rates and decided not to..... They put a huge amount of weight on what's happening in the mining sector by the looks of this. So we'll see whether it's mining versus the rest of the economy - who wins out?" The Sydney Morning Herald quoted Mr Koukoulas.

Mr Stevens added that the RBA took into account the recent developments in the U.S. economy, particularly the improvement in employment rate and other global developments in Europe and China.

"Recent data from the United States suggest a continuing moderate expansion after a soft path in mid 2011," Mr Stevens said.

"Growth in China has moderated as was intended, but on most indicators remained quite robust through the second half of the year," he added.

Various sectors such as the retail industry which suffered a slump in 2011 supported the call for a rate cut, but analysts and economics were 50-50 on a rate cut decision and thought the central bank would adopt a wait and see approach.

ANZ Bank, which announced independence from RBA policies in setting interest rates, was the only major Australian bank to correctly forecast the central bank's decision.

"The economy seems to have stabilised over the Christmas and January period and there is enough to keep the RBA on hold at least until March but it will be a very close call," The Herald Sun quoted ANZ head of Australian economics Katie Dean.

With the RBA decision, Australian lenders which are under pressure to pass in full any central bank rate reduction can heave a sigh of relief temporarily. The relief would be particularly felt by the National Australia Bank (NAB) which reported a first quarter cash earning result of $1.4 billion on an unaudited basis, up from $1.3 billion for the same period the previous year.

CMC markets chief market strategist Michael McCarthy had commented before the RBA decision came out that based on NAB's 7.7 per cent quarterly profit hike, the lender could afford to pass in full to borrowers any cut the central bank would make.

The same call was made on the big four by the Australian Confederation of Trade Unions which cited the combined profits of $25.2 billion as justification for passing on in full RBA rate reductions.

NAB economist Ali Knight stressed that despite the close call of the RBA decision, the announcement does not rule out future rate cuts which the bank economists expect at least one more in the next six months.

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