Australian inflation stays low but it may not be enough to see the RBA cut rates

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Australia’s Q2 consumer price inflation report (CPI) has come in slightly hotter-than-expected, creating some doubt as to whether the Reserve Bank of Australia will cut interest rates again when it meets on August 2.

Core inflation, the focus of financial markets given its influence over the outlook for Australian interest rates, increased by 0.45% according to the ABS, slightly above expectations for a gain of 0.4%.

The year-on-year rate came in at 1.5%, down from 1.55% from Q1, although it was above forecasts for an increase of 1.4%.

While the lowest year-on-year core inflation rate on record, it is now exactly in line with forecasts offered by the RBA in its most recent statement on monetary policy, released in early May.

To formulate the forecasts, the RBA used prevailing interest rate expectations at the time, something that were pricing in a cash rate of 1.5% by early 2017.

This suggests that a further rate cut is still possible, although it whether it arrives in August is now questionable.

While the core inflation was slightly above expectations, headline inflation came in smack bang on forecast, rising 0.4% for the quarter.

Despite the modest increase, the year-on-year rate tumbled to just 1.0%, below forecasts for a gain of 1.1%, leaving it sitting at the lowest level seen since the June quarter of 1999.

According to the ABS, the most significant price rises were for medical and hospital services (+4.2%), automotive fuel (+5.9%) and tobacco (+2.1%), partially offsetting declines in domestic holiday travel and accommodation (–3.7%), motor vehicles (–1.3%) and telecommunication equipment and services (–1.5%).

The ABS note that the 4.2% increase in medical and hospital services was driven by an increase in Private Health Insurance (PHI) premiums, which rise on 1 April every year.

By component, tradable inflation — that influenced by global factors — increased by 0.6% for the quarter, leaving the year-on-year rate unchanged.

The ABS note that the most significant contributor to the increase in tradable inflation was automotive fuel.

Non-tradable inflation, that influenced by domestic factors and comprising 60% of the ABS’ CPI basket, increased by 0.35% for the quarter, leaving it up 1.6% from the same quarter in 2015.

The quarterly increase was the weakest since Q2 2010, with the year-on-year rate falling to levels last seen in Q2 1999.

The most significant contributors to came from new dwelling purchase by owner-occupiers and medical and hospital services, according to the ABS.

The table below, supplied by the ABS, breaks down the change in headline consumer prices, both from a quarterly and year-on-year perspective.

Following the release of the report, financial markets have wasted no time in pricing out the likelihood that the Reserve Bank of Australia will cut interest rates when it meets on August 2.

Cash rate futures currently put the odds of a 25 basis point rate cut at around 50%, down from 67% prior to the release, while Australian 3 and 10-year bond futures have weakened by 4 and 3.5 ticks respectively.

Despite the swift reaction in interest rates, the move in the Australian dollar, as yet, has been muted.

The AUD/USD currently trades at .7524, up 0.3% for the session. It briefly rose as high as .7564 in the immediate aftermath of the release.

The ASX 200, after opening higher, has slipped into the red. It currently trades at 5331.2, down 0.11% for the session.

All prices are correct as at 11.54am AEST.

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