TWO further interest rate cuts over the coming months will be enough to kick start the struggling retail and housing sectors, according to HSBC chief economist Paul Bloxham.

The former Reserve Bank economist says the Australian economy is in a strong position, with the mining boom set to drive around 60 per cent of GDP growth this year.

Reserve Bank Governor Glenn Stevens is widely tipped to lower rates to 4 per cent on Tuesday, with a further 25-basis point cut to follow around mid-year.

Releasing HSBC's latest report on the Australian economy, Mr Bloxham said betting on futures markets - which suggest that rates will drop as low as 3.25 per cent this year - was off target.

Even if the banks fail to pass on the full rate reductions to borrowers, HSBC expects the RBA to keep the cash rate on hold after cutting it to 3.75 per cent.

HSBC's report came as new data indicated the manufacturing sector was beginning to show signs of a recovery. Mr Bloxham is forecasting a "soft landing" for China as the global economy slows, cushioning Australia from a US recession.

More than 70 per cent of Australian exports go to Asia. "Since the global financial crisis in 2008, Asian economies have managed to switch their economies from being reliant on exports for growth to being driven by domestic demand," he said.

"The problems in Europe haven't been fixed ... but the RBA has the firepower to use monetary policy to support the weaker parts of the economy."

But Mr Bloxham conceded the withdrawal of capital by European banks squeezed for funding could affect Asia. European banks are currently the biggest lenders to Asian companies and governments.

HSBC is tipping Australian unemployment will rise slightly over the coming months, peaking at around 5.5 per cent in late 2012.

The dollar is also tipped to drop to around US95c by the end of the year, increasing inflationary pressures in the economy.

After being bruised by the Australian dollar's rise above parity, manufacturing is slowly recovering, according to separate research released yesterday.

The Australian Industry Group and PricewaterhouseCooper's performance of manufacturing index crept higher last month, climbing 1.4 points to 51.6. Readings above 50 points indicate that the sector is expanding.

CommSec economist Savanth Sebastian said it was only the second time in seven months the manufacturing index had been in positive territory.

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