Australia's latest inflation data has come in on the firm side of expectations, but to a mixed reaction by markets. While pricing for an RBA rate hike in February lifted from around 60% to 70%, the 3-year government bond yield was 4-5bps lower and the Australian dollar softened from multi-year highs overnight. In my view the muddled reaction reflects what has unfortunately turned out to be a rather messy transition from quarterly to monthly inflation data. Markets were cued up for quarterly figures that the RBA has said it will continue to set policy to, but the ABS focused its reporting on its new monthly format.
Markets had to dig deep into the release to find those key quarterly figures. In the December quarter, headline CPI was 0.6% - well down from the 1.3% acceleration in the September quarter - but base effects lifted the annual pace from 3.2% to 3.6% - its highest since the June quarter of 2024. Market forecasts were around the money at 0.6%q/q and 3.5%Y/Y. Meanwhile core or trimmed mean CPI was 0.9% for the December quarter, only a touch softer than the 1% increase in the September quarter. The annual pace rose from 3% to 3.4%. Both quarterly and annual trimmed mean were hotter than the market's forecasts for 0.8%q/q and 3.2%Y/Y.
Importantly, the latest inflation numbers have come in above the RBA's forecasts, which were for headline CPI of 0.5%q/q and 3.3%Y/Y and trimmed mean of 0.8%q/q and 3.2%Y/Y. While those forecasts are dated (they will be updated in February), the central bank has been talking about the risk of inflation surprising to the upside. And that is what has played out. The increase in market pricing for a February hike is justified because the Monetary Policy Board may take higher-than-expected inflation as an indicator that demand conditions (including household spending and the labour market) are starting to put upward pressure on prices. The RBA had attributed the surge in inflation in the September quarter largely to temporary factors; however, even if some of the large price increases were not repeated in the December quarter, inflation has still come in a bit higher than anticipated.
An opposing viewpoint is that the RBA may show patience due to significant volatility in the inflation data, a situation now amplified by the switch from quarterly to monthly data. Electricity prices for example are up 21.5% over the year as government rebates have unwound, while there have a been other outsized price increases of late such as property rates and in holiday travel, the latter heavily influenced by seasonality. Overall, today's inflation numbers make the RBA a bit more likely to hike in February, but a hold cannot be completed ruled out.
