By Stella Qiu
SYDNEY (Reuters) -Australian inflation was surprisingly strong in the third quarter amid broad-based and stubborn cost pressures, a headache for policymakers that added greatly to the risk of a rise in interest rates as early as next month.
Investors reacted by narrowing the odds on the Reserve Bank of Australia (RBA) restarting the tightening cycle in November after four rate pauses, with futures now pricing in a 66% chance of a quarter-point hike to 4.35%, compared with 35% before the data.
Data from the Australian Bureau of Statistics on Wednesday showed the consumer price index (CPI) rose 1.2% in the third quarter, above market forecasts of 1.1% and up from a 0.8% increase the previous quarter.
The annual pace of inflation slowed to 5.4%, from 6.0%, but was again above forecasts of 5.3%. For September alone, the CPI rose 5.6% year-on-year, up from 5.2% in August.
Worryingly, a closely watched measure of core inflation, the trimmed mean, rose 1.2% in the third quarter, to top forecasts of 1.1%. The annual pace slowed to 5.2%, from 5.9%.
Two of the four major Australian banks - the Commonwealth Bank of Australia (OTC:CMWAY) and ANZ - abandoned their rate pause view on Wednesday. Both now see a quarter-point hike in November.
"While 4.35% should mark the peak in the cash rate, there is a risk it could tighten beyond that. Any easing remains a very long way off," said Adam Boyton, head of Australian Economics at ANZ.
Gareth Aird, head of Australian Economics at CBA, expects a rate hike in November would enable the RBA to retain its central case for inflation to return to the target band by late 2025.
The Australian dollar rose 0.5% to a week high of $0.6385 and three-year bond futures tumbled 15 ticks to 95.68, the lowest since 2011. Markets are now seeing rates peaking at 4.46% early next year, up from 4.35% before the data release.
Any hike would put the RBA in the unusual position of being one of the very few central banks in the developed world still tightening policy. Markets are wagering both the U.S. Federal Reserve and the European Central Bank are done with hiking.
HAWKISH MESSAGING
The recent messaging from the central bank has been on the hawkish side. Michele Bullock, the new RBA governor, on Tuesday said in her first public speech that the central bank would not hesitate to hike further if there is a material upward revision to the inflation outlook.
She is scheduled to appear before lawmakers on Thursday, and will have an opportunity to comment on the strong inflation data.
The biggest contributors to the third quarter inflation were fuel, rents, and electricity. Fuel prices rose 7.2% from a year ago, reversing two quarters of price falls, with the conflict in the Middle East potentially set to further stoke inflationary pressures.
Inflation remained elevated for a range of services such as vets, restaurant meals and hairdressers. Rents rose 7.6% from a year ago, the fastest since 2009.
One silver lining in the report is that food prices registered the slowest quarterly rise in two years as prices fell for fruit and vegetables.
Supermarket giant Woolworths said on Wednesday that average prices for the products it sold in the September quarter rose just 2% over a year earlier, a significant moderation compared with previous quarters.
The central bank forecast in August that inflation was only projected to return to the top of the bank's target band of 2-3% in late 2025. It will release its updated economic forecasts in early November.
National Australia Bank (OTC:NABZY), which has called for a hike in November, notes the risk of another rate rise to 4.6%, as they expect the RBA to revise up the near-term inflation forecasts.
"The RBA's August forecast embedded a hope that they were already making in-roads into that demand driven domestic inflation problem," said Taylor Nugent, a senor economist at NAB.
"The key implication of today’s data is that that hope was misplaced."