The cut, which had been long anticipated, brought rates down to their lowest level since December 1994 when the central bank had been tightening aggressively to pre-empt higher inflation.
Its a reward for low inflation and wage restraint, Prime Minister John Howard told reporters.
Howard said the rate cut would help job creation and boost the Australian economy.
It will encourage people to take more risks to invest, to have a go and all of that helps, Howard said.
The rate cut was the second this year, after the central bank reduced rates from 7.5 percent to 7.0 percent on July 31, citing continuing high unemployment.
Australias four big commercial banks took the hint on Wednesday and quickly slashed their variable mortgage rates by the full 0.5 point, bringing the standard rate down to 8.75 percent.
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In a statement accompanying the cut, the RBA said the decison had been taken at its monthly board meeting on Tuesday.
This decision was taken by the board yesterday in view of the improvement in the outlook for inflation, which has increased the scope for the economy to sustain a faster rate of growth, the bank said.
The bank said inflation had returned to its target range of two to three percent, adding that a firm exchange rate had helped ease inflationary pressures.
Underlying inflation slowed to 2.4 percent in the third quarter from 3.1 percent in the three months to June.
Economists welcomed the easing, saying it was fully justified by the countrys favourable inflation performance and should ensure economic growth picked up as expected in 1997.
The fact the cut was not as large as some in the market had been tipping suggests the RBA is not that worried about the economic outlook, said Ivan Colhoun, an associate director at Bain & Co, the Australian arm of Deutsche Morgan Grenfell.
We think the economic data over the next month or so will be soft enough to make the market look for another easing, but it will depend crucially how inflation and wages perform and that will not be clear until February, he said.
Financial markets took the move in their stride and were already busy assessing the chances of a third easing this year.