Australia's core inflation rate accelerated to its fastest pace in 16 years last quarter, adding greatly to the domestic case for a rise in interest rates even as turmoil in global markets seemed to argue against one.
The Australian dollar firmed while bond futures slid on Wednesday after data showed core inflation rose 3.6 percent on average in the year to December. That topped forecasts of 3.3 percent and, critically, was far above the Reserve Bank of Australia's (RBA) 2 percent to 3 percent comfort zone.
"Core inflation of 3.6 percent is just way too high, and, on my projections, it looks like staying up there all this year," said Su-Lin Ong, a senior economist at RBC Capital Markets. "There's still a tug-of-war between domestic pressures and the deteriorating global outlook, but these numbers clearly raise the probability of a hike next month," she added.
The market seemed to agree and instantly priced in a 50/50 chance the RBA's policy board would raise the 6.75 percent cash rate when it next meets on Feb. 5. The probability of a move had been down under 10 percent on Tuesday as the local share market slumped and fears grew of a U.S. recession.
The extent of global uncertainty was driven home in dramatic fashion late on Tuesday when the Federal Reserve slashed U.S. interest rates by 75 basis points to 3.5 percent, the biggest cut in 23 years. And the market was still pricing in a further easing at its scheduled policy meeting next week.
The International Monetary Fund also chimed in, saying a significant slowdown in global economic growth was inevitable.
"The RBA is stuck between an inflationary rock and a very difficult international hard place," said Matthew Johnson, a senior economist at ICAP. "I don't think it's clear which way they are going to move, but they are under strong pressure to raise rates as a result of those inflation numbers."
The RBA lifted rates twice last year, taking them to an 11-year high of 6.75 percent, in an attempt to cool the economy and contain inflation. Yet domestic demand has continued to run hot, showing little sign of credit contagion as yet.
Just last week, RBA Governor Glenn Stevens expressed confidence that the economy could weather the global storm and highlighted the dangers of inflation.
Wednesday's data would only have heightened his concerns.
When setting interest rates, the RBA focuses on two measures of underlying inflation, which strip out the biggest moves in any quarter in the hope of divining the true trend.
These measures rose by an average 1.05 percent in the fourth quarter of last year, well above forecasts of a 0.8 percent rise.
That took the annual rate to an average 3.6 percent, up from 3.0 percent in the third quarter and the fastest pace since the third quarter of 1991.
The government's broadest measure of inflation, the consumer price index (CPI) rose 0.9 percent in the fourth quarter. The annual pace of CPI inflation accelerated to 3.0 percent, from just 1.9 percent in the third quarter.
The main price pressure came in petrol, housing, financial services and holidays. Big falls in fruit and vegetable prices provided some offset.
"In some ways this result makes the RBA's decision easier," said Michael Blythe, chief economist at Commonwealth Bank. "The numbers show a clear inflation problem they need to deal with."
"You would need to see some exceptional developments on the global front to head off that rate rise now."