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Australia Inflation Slows, Curbs Rate Risks

Reuters
Tuesday, 23 Jan 2007 | 10:44 PM ET

Australia's underlying inflation rate slowed by more than expected in the fourth quarter while consumer prices fell for the first time in eight years, greatly lessening the risks of another rise in interest rates.

The Australian dollar slid three-quarters of a U.S. cent while bond futures surged after two key measures of underlying inflation calculated by the country's central bank rose by 0.5% last quarter.

That was below market expectations for increases of 0.7% and dragged the annual rate down to an average 2.95 percent, putting it back within the Reserve Bank of Australia's (RBA) 2% to 3% target band.

"The RBA's preferred measure of inflation has slowed enough that the central bank will not be hiking rates in February, that's 99.9 percent sure," said Rory Robertson, interest rate strategist at Macquarie Bank.

The central bank holds its first policy meeting of the year on Feb. 6 and there had been considerable speculation it could tighten policy for a fourth time in ten months given a widespread lack of spare capacity in the economy.

The consumer price index actually fell 0.1% in the fourth quarter, the first drop since early 1999 and well below market forecasts' of a 0.2% rise.

A huge 12% fall in petrol prices played a major part in the result, while the cost of fruit, clothing, household appliances and pharmaceuticals all dropped. The annual pace of consumer price inflation slowed to 3.3%, from 3.9% in the third quarter and a peak of 4.0% in the second.

Still Watching Wages

"Excellent results," said John Edwards, chief economist at HSBC. "It means there will not be an interest rate increase at the February RBA meeting and interest rates have peaked. There won't be any interest rate increases for the rest of the year."

The government, which is expected to call an election late in 2007, certainly shared that view, saying it hoped there would now be no reason for a rate rise.

Not all analysts were bold enough to completely rule out another move, noting that employment remained very strong and a jobless rate at 30-year lows of 4.6% meant there was still a risk of rising wages spilling over into inflation. "The RBA won't sound the all-clear on inflation until it sees the unemployment rate move up from its three-decade lows," said Robertson at Macquarie. "So, its tightening bias is still in place."

Others pointed out that rising demand for labor had been met by rising supply as more people joined the labor force, and this had helped stabilize the jobless rates. "Concerns about tight labor markets and wages won't go away any time soon, but on these sorts of numbers it doesn't appear to be flowing through to any sort of generalized wage or price increases," said Michael Blythe, chief economist at Commonwealth Bank.

He also argued that the low reading for consumer prices would help massage inflation expectations lower among the public and businesses, helping restrain wages further.

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