Underlying inflation in Australia speeded past expectations last quarter to hit the very top of the central bank's target range, sharply lifting the risks of a hike in interest rates as early as next month.
The Australian dollar climbed while bond futures sank as the market priced in an 86 percent chance the Reserve Bank of Australia (RBA) would raise rates at its Nov. 6 policy meeting. Just hours earlier the risk had stood at 50 percent.
Any hike in November would be the first during an Australian election campaign and a real headache for a government touting its economic record but trailing badly in the polls.
"Given the pattern of the past 18 months, this high underlying reading effectively sets the seal on a rate hike at the RBA's next meeting," said Su-Lin Ong, a senior economist at RBC Capital Markets.
Average underlying inflation rose 0.95 percent in the third quarter, even faster than the previous quarter's 0.9 percent increase. Average annual inflation picked up to 3.0 percent, the very top of the RBA's comfort zone, from 2.8 percent in the second quarter.
Core inflation has surprised on the high side on four occasions since the start of 2006 and each was followed by a rate rise from the central bank.
"The more important question now, is how much further will they have to go past that. We could see the market price in a second and even third hike," said Ong.
The RBA lifted rates to a decade-high of 6.5 percent in August, seeking to cool the economy and avoid a future break of its 2 to 3 percent target band for underlying inflation.
But there have been few signs of any slowdown, with brisk employment growth driving the jobless rate to 33-year lows while households borrowed and spent freely.
Widespread drought has also put upward pressure on food, water and utility prices, while a strong housing market has seen rents climb.
It's The Core That Counts
The RBA focuses on measures of core inflation, which exclude the most volatile price moves in any one quarter, in the hope of detecting the underlying trend in price pressures.
"The core numbers are the ones that matter," said Stephen Walters, chief economist at JPMorgan. "They both came in higher than expected. That does suggest to us that the Reserve Bank is going to raise interest rates in a couple of weeks time."
In contrast, the government's measure of consumer prices (CPI) rose only 0.7 percent in the third quarter, short of market forecasts of a 0.9 percent increase.
Still, the undershoot was due to a huge 33 percent drop in child care costs as a government child care rebate came in. Without that, the CPI would have risen much as expected.
The central bank might still pause given uncertainty over the U.S. economy coupled with the logjam in global credit markets, which had forced some smaller institutions in Australia to nudge up interest rates in recent weeks.
Investors expect the Federal Reserve will cut U.S. interest rates next week, and analysts wonder if the RBA would want to be seen tightening at home only a few days later.
"There are still plenty of reasons for a cautious approach by the RBA, but given their commentary on the inflation trajectory it will be difficult to resist raising rates in November," concluded Michael Blythe, chief economist at Commonwealth Bank.