(Add comments and New Zealand dollar)
By Cecile Lefort and Charlotte Greenfield
SYDNEY/WELLINGTON, May 17 (Reuters) - The Australian dollar rallied 1 percent on Tuesday after minutes of the Reserve Bank of Australia's (RBA) May policy meeting encouraged markets to pare back the chances of a cut in interest rates.
The Aussie leapt to $0.7358, away from a 2-1/2-month trough of $0.7236 touched on Monday. Resistance was found at $0.7375, then more solidly at $0.7453, a major retracement level.
It regained vigour against the euro and yen following recent steep losses.
In minutes of the policy review, where the RBA reduced the cash rate by a quarter point to a record low 1.75 percent, it appeared less dovish than some had anticipated. minutes confirmed it was a line-ball decision on whether to cut or not," said Su-Lin Ong, a senior economist at RBC Capital Markets. "The market will derive that another cut in the near-term is unlikely but we are not so sure."
Ong forecasts an easing in June to a record low of 1.5 percent.
Bond prices fell with interbank futures 0#YIB: pricing a 26 percent chance of a cut in July, from 36 percent before the minutes. Yet, they are still fully priced for a move by the end of the year.
Australian government bond futures dropped sharply, with the three-year bond contract YTTc1 off 8 ticks to 98.390. The 10-year contract YTCc1 shed 6 ticks to 97.7150 in a bearish flattening of the curve. The 20-year contract YXXc1 slipped 5 ticks to 97.0900.
The two-year cash bond yield rose to 1.6 percent, having touched a record low of 1.5 percent on Monday.
Aussie buying dragged the New Zealand dollar NZD=D4 higher to $0.6823, from as low as $0.6748 the previous day.
The global dairy prices auction held early on Wednesday morning would also show whether global dairy prices were continuing to fall, which could drag on the Kiwi.
Analysts expected the New Zealand dollar to trade between $0.6750 and $0.6840.
New Zealand government bonds 0#NZTSY= eased, sending yields 3.5 basis points higher at the long end of the curve.