By Roushni Nair

(Reuters) - Australia's biggest banks face a pivotal earnings test next week as they navigate mixed interest margin prospects in the face of looming rate cuts, persistent inflation concerns and rising mortgage stress.

The results arrive after a politically-charged election set for May 3 dominated by cost-of-living anxieties that are reshaping banks' mortgage books and consumer lending patterns.

The Reserve Bank of Australia delivered its first interest rate cut since November 2020 in February, signalling a potential turning point for bank margins after higher rates supercharged competition.

Bank shares, which initially underperformed after the rate cut due to frothy valuations and disappointing earnings, rebounded following U.S. President Donald Trump's announcement of sweeping tariffs on April 2 as investors sought safe havens with minimal exposure to global trade disruption.

The financial sub-index has risen nearly 4% since then, though Citi analysts note this "safe haven trade was not broad, seeing investors concentrate into Commonwealth Bank of Australia over the past month with more middling share price returns elsewhere." CBA shares are hovering near a record high hit on April 23.

Investors expect another quarter-point rate cut from the RBA on May 20, though some have scaled back forecasts of five rate cuts this year following a stronger-than-expected reading in headline inflation. [0#AUDIRPR]

If the domestic economy holds up, rate cuts may lead to stronger housing credit growth as increased borrowing power flows through to higher house prices and larger loan sizes, Macquarie analysts say.

MARGINS UNDER PRESSURE

Westpac, Australia's second-largest mortgage lender, opens the bank reporting season on Monday with an expected 2.6% rise in first-half net profit, according to market data aggregator Visible Alpha.

National Australia Bank, the top business lender, is expected to report a near 2% drop in half-year cash earnings, while ANZ Group is forecast to report largely flat earnings, according to Visible Alpha.

"If an economic slowdown proves worse than anticipated and bad debt provisions rise, NAB and ANZ could be particularly vulnerable given their higher exposure to business lending," UBS analysts warned.

ANZ faces additional risk due to its very low starting levels of bad debt provisions, potentially leaving it more exposed to deteriorating economic conditions, they added.

CBA, the country's biggest lender, gives a third-quarter trading update on May 14, with Citi analysts expecting a slight margin decline of 2 basis points but a profit increase of up to 7%.

For the first half of 2025, Westpac's net interest margin is forecast at 1.91%, slightly above last year's 1.89%, while NAB is expected to see margins contract to 1.69% from 1.72%. ANZ's margin is projected to edge up to 1.58% from 1.56%.

(Reporting by Roushni Nair and Himanshi Akhand in Bengaluru; Editing by Sonali Paul)