Yesterday’s shock inflation figure means you can say goodbye to further interest rate cuts

Yesterday’s shock inflation figure makes further interest rate cuts unlikely, and lays the groundwork for the Reserve Bank to hike interest rates in 2014.

The 0.8% quarterly rise in the consumer price index surprised the nation’s markets on the upside – most had been factoring in a 0.5% rise.

It’s also above the RBA’s own Statement on Monetary Policy, released in November 2013, which forecast 2013 would end with inflation at 2.5%. Inflation for the year is now at 2.7% – heading towards the top of the RBA’s 2-3% target band.

“The magnitude of the increase this quarter surprised us,” Westpac chief economist Justin Smirk says.

This is despite the bank expecting to see some inflation arising from the weaker Australian dollar, which makes imports more expensive.

It puts a stop to speculation that the RBA could cut interest rates – already at record lows – to stimulate the economy and ease its transition away from the mining boom.

“If the numbers are a true reflection of inflation, rate cuts from here now look extremely unlikely, especially given the lower currency and momentum gathering in some areas of the economy,” said ANZ senior economist Riki Polygenis.

She added that most commentators have previously figured the RBA isn’t too concerned with inflation at the moment. “At first glance, these figures do question [that assumption].”

The only way the RBA can fight inflation is through raising interest rates. Commentators are divided on whether yesterday’s inflation figure is enough to see the RBA push the brakes.

One economist who thinks a rate hike is now on the horizon is Market Economics’ Stephen Koukoulas. Prime Minister Julia Gillard’s former economic adviser said Australia wouldn’t have an inflation problem, provided the RBA “does its work and adjusts interest rates according to this new information”.

“A rate hike in March, with more through 2014, looks the best policy approach,” he said.

Driving the increase was a rise in non-tradable inflation, which refers the rise in price of things that aren’t imported such as fast food and utilities. Non-tradables rose 0.8% in the quarter, taking their yearly rise to 3.7%. Such goods comprise 60% of the weighting of the Consumer Price Index, so the rise was a large contributor to December’s increase.

Despite the lower Australian dollar, tradable inflation was more subdued, rising 0.7% in the quarter. That takes tradable inflation to 1% in the twelve months to December.

The fastest-rising individual category was recreation and culture, which represents holiday travel, where prices rose 2.1%. Food and beverages also rose 1.6%, communication services rose 1.2%, while housing rose 0.5% in the quarter.

Alcohol and tobacco rose 1.6%, but the main contributor to this was a rise in the federal excise tax on tobacco that kicked in from December 1, 2013.

Perhaps due to the end-of-year-sales, clothing and footwear actually saw price deflation of over 1% in the December quarter. Also falling were health and transport costs, while education costs remained steady.

A higher CPI can mean automatic wage hikes for many of the country’s employers, as contracts typically stipulate annual wage increases in line with inflation as a bare minimum.

Smirk doesn’t think employers will get much relief from this.

“Without a significant further dip in the [Australian dollar], we still see inflation peaking around 3.0% in early 2014,” he said.

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