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Australia's Core Inflation Hits 17-Year High

Core inflation in Australia accelerated to its fastest annual pace in 17 years last quarter as the cost of fuel, financing and rents all climbed, suggesting interest rates would have to stay high for some time to come.

Austrailia, Austrailian Flag
CNBC.com
Austrailia, Austrailian Flag

Still, the pick-up was much as expected by the Reserve Bank of Australia (RBA) and should not shake its belief that a cooling economy will curb price pressures over the next year or two.

"Inflation is still too high, but the Reserve Bank believes demand is slowing and prices will ease in time," said Brian Redican, a senior economist at Macquarie. "The next move in rates is likely to be down, but not for a long while yet."

Investors saw the data reaffirming the status quo on policy and the Australian dollar stayed soft as the market priced in a steady 7.25 percent cash rate for the rest of the year.

When setting policy, the RBA focuses on the average of its two statistical measures of core inflation, which strip out the biggest price moves in any quarter.

On this basis, core inflation rose 1.1 percent in the second quarter, compared to the previous quarter when it increased by 1.2 percent. The average annual pace of core inflation climbed to 4.4 percent, from 4.2 percent in the first quarter.

That was the fastest pace since 1991 and far above the central bank's target of 2 percent to 3 percent.

Yet RBA Governor Glenn Stevens had flagged that inflation would increase more than 1.0 percent in the quarter, arguing that policy was already tight enough to ensure a necessary slowdown in domestic demand.

"It looks more likely now than it did a couple of months ago that this more moderate track for demand will continue," Stevens said just last week.

Bank Inflation

Retail sales have been subdued so far this year, with consumer sentiment hitting depths not seen since the 1990/91 recession, while appetite for credit has slumped.

Banks have added to the gloom by lifting their mortgage rates to around 9.5 percent amid the global credit squeeze. Indeed, higher financial costs were a major source of inflation last quarter.

The government's broadest measure of inflation, the consumer price index (CPI), jumped a surprisingly high 1.5 percent in the quarter. That lifted the annual pace of CPI inflation to 4.5 percent, the fastest pace since 2001 when the index was biased upward by the introduction of a sales tax. The cost of financial services surged 3.8 percent in the quarter and were up almost 10 percent in the year as banks pushed up rates and fees.

An 8.7 percent jump in petrol prices added to the inflationary mix, while the cost of rents, healthcare, housing, clothing and alcohol all showed increases.

Su-Lin Ong, a senior economist at RBC Capital Markets, fretted that price pressures were so broad-based, noting annual inflation for non-tradeable goods and services, which are mainly sourced domestically, was running at a torrid 5.6 percent.

"It has to be worrying that so much inflation is home-grown. It's just as well the strong Australian dollar is helping keep down imported prices," said Ong. "The RBA will likely look through this as long as demand remains sub-par, but it's a tight call. Talking of rate cuts by early next year seems premature," she added.

The wait could be a long one, given the RBA itself does not expect inflation to moderate to 3 percent until mid-2010.