September quarter inflation was released today, indicating that inflationary pressures in the Australian economy have eased a touch. The data released by the Australian Bureau of Statistics indicated that annual headline inflation has declined by 0.1% to 3.5%. The most significant price rises over the quarter came from the housing sector with water and sewerage (+8.6%), electricity (+7.8%), and property rates and charges (+5.2%) being partially offset by declines in pharmaceuticals (-5.0%), vegetables (-2.5%), petrol (-1.4%) and fruit (-1.2%). While headline inflation remains well above the RBA’s target band, its preferred core measure (which removes the impact of volatile items such as food and energy) came in at an annual rate of around 2.5% which is well within the target band and was below market expectations. This suggests that pricing power in the Australian private sector remains weak.

The Australian sharemarket immediately rallied and the currency declined against all of its major peers, as financial markets began to factor in an easing of the RBA’s Target Cash Rate next Tuesday. This move followed statements by RBA officials earlier this month that improved inflation would increase the ability of interest rates being reduced to support demand (should that prove necessary). Today’s result and the RBA’s already flagged downward revisions to near-term economic growth, suggest that they will reduce their inflation forecast in the upcoming Quarterly Statement of Monetary Policy (due out 4th November 2011).

This combination suggests the main concern about the Australian economy is swinging from inflation to growth and this provides the RBA with the ability to cut rates, but not necessarily on Tuesday. The RBA has suggested the key reason for cutting rates would reflect trends in Europe. There would be no point firing its ammunition before the enemy has arrived. The likelihood of a November rate cut from the RBA (next week) has risen significantly, but it might be more prudent for the RBA to wait and see how the rescue package in Europe is received before doing anything. The European deal has looked a bit less certain in recent days and any negative developments in the next few days could push the RBA over the line. But it’s not yet the sure thing that the market thinks.

Article by Matt Sherwood at Perpetual