Published: Wednesday, 28 Oct 2009 | 1:44 AM ET

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Australian consumer inflation rose by more than expected last quarter as utility and fuel prices
jumped, yet the increase was not considered alarming enough to justify a more aggressive tightening in interest rates.

The Australian dollar dipped and interbank futures rallied as investors pared back the risk of the Reserve Bank of Australia (RBA) raising its cash rate by 50 basis points at its policy meeting next week, rather than by 25 basis points.

"This number's just not bad enough to trigger anything other than a quarter point rate rise," said Stephen Walters, chief economist at JPMorgan.

One measure of market expectations from Credit Suisse showed around a 20 percent chance of the RBA raising rates by 50 basis points, compared to as much as 60 percent a couple of weeks ago.

This month, the RBA became the first in the Group of 20 industrialised nations to raise rates since the global credit crunch began, lifting its cash rate by a quarter of percentage point to 3.25 percent.

There had been fears a really high inflation reading could prompt a more drastic tightening of half a percentage point when the central bank meets on Nov. 3.

"They are certainly consistent with the idea the Reserve Bank will lift rates, but the outcome is probably more in line with a 25 basis-point move than 50," was the judgement of Michael Blythe, chief economist at Commonwealth Bank.

"It seems there is no need for the central bank to speed up interest rate cycle."

Low Point

The headline measure of consumer prices rose 1.0 percent in the third quarter, topping forecast of 0.8 percent and double the increase seen in the second quarter.

The main drivers were a big rise in housing costs, as the price for electricity jumped 11.4 percent and water 14.1 percent, while petrol climbed 4 percent.

That was tempered in part by a sharp drop in fruit and vegetable prices and lower costs for pharmaceuticals.

Despite the sizeable increase in the quarter, the annual pace of consumer price inflation slowed to 1.3 percent, which was actually the lowest since 1999 and a long way from last year's 5.0 percent peak.

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It was also under the RBA's long-term target of 2 to 3 percent.

Yet analysts suspect it will be the low point for the cycle and the annual pace will pick up from here, an outlook shared by the central bank, which is forecasting a rate of 2.25 percent by
the end of this year.

Earlier this month, the RBA warned that underlying price pressures had not eased as much as previously hoped and that keeping rates so low would jeopardise its inflation target.

Two measures of underlying inflation favoured by the central bank increased by an average of 0.75 percent in the third quarter, a touch above market forecasts.

The average annual pace slowed to 3.5 percent, still above the central bank's target band.

"The stronger economy and resilient labour market suggests core inflation is likely to trough at a higher level that we thought and in the upper half of the inflation band," said Su-Lin Ong, a senior economist at RBC Capital Markets.

"That gives the RBA limited room for policy error and argues for a return to a neutral rate poistion between 5 and 6 percent over next year," she added.

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