Published: Tuesday, 21 Jul 2009 | 11:29 PM ET

Text Size

Australian consumer price inflation slowed to it lowest annual pace in a decade last quarter as falls in food and financing costs helped offset increases in health, clothing and rents.

Yet measures of underlying inflation favoured by the Reserve Bank of Australia (RBA) showed domestic price pressures were proving more stubborn than many had hoped, reinforcing speculation the central bank was done cutting interest rates.

"The RBA would be disappointed that the underlying measures f inflation aren't coming down faster," said Paul Brennan, head of market economics at Citi. "Given that the economy looks like it's recovering a lot better than we all thought it would, it suggests you wouldn't want to see rates cut any further."

Investors reacted by pricing in a greater chance the next move in rates would be up, perhaps by early next year, and bond futures skidded while the Australian dollar edged higher.

The central bank cut rates by a steep 425 basis points between September and April but has held them steady at 3 percent since as household demand held up better than expected.

The RBA is still forecasting a significant easing in underlying inflation over the next year or two, thanks in large part to the dampening effect of the global recession.

On the face of it, the news seemed promising.

The headline consumer price index (CPI) rose only a moderate 0.5 percent in the second quarter, as expected. The annual pace slowed to 1.5 percent, down from 2.5 percent the previous quarter and the lowest since 1999.

That was a marked turnaround from last year when raging  energy prices pushed CPI inflation as high as 5 percent. It was also below the RBA's long-term target band of 2 to 3 percent.

Underlying Pressure

Yet when setting policy the central bank focuses on an average of its two statistical measures of underlying inflation, which strip out the most extreme price moves in a quarter to better determine the trend.

By those measures, underlying inflation rose 0.8 percent in the quarter while the annual pace slowed only slightly to 3.9 percent, from 4.15 percent in the first quarter.

Price growth has been particularly stubborn in services like health and education that are not open to international competition.

More From CNBC.com

• RBA More Upbeat in July Minutes
• Australia Producer Prices Fall By Record
• Australia Unions Urge More Stimulus to Guard Jobs
• More Asia Pacific News

That could challenge the RBA's assumption that disinflation around the world and rising unemployment at home will eventually pull core inflation down under 2 percent by 2011.

"It was quite disappointing to see the breadth of price increases last quarter," said Brian Redican, a senior economist Macquarie.

Furniture, clothing, petrol, health care, rents, alcohol and tobacco all showed increases.

"The burden is still on underlying inflation to come down further to justify the RBA's optimism," added Redican. "This will keep rates firmly on hold."

Print

Email

Text Size