• Australia’s main inflation measure – the consumer price index (CPI) – rose by 0.7 per cent in the September quarter, well below economist forecasts. The annual rate of consumer inflation eased from 3.1 per cent to 2.8 per cent – in other words back inflation is back in the Reserve Bank’s 2-3 per cent target band.
• Higher prices for tobacco, water and sewerage, electricity, property rates and rents were partially offset by lower prices for petrol, vegetables, electrical goods and pharmaceuticals.
• The Reserve Bank focuses on three “underlying” price measures – trimmed mean, weighted median and CPIX (CPI less fruit, vegetables, petrol and deposit and loan facilities). The trimmed mean rose 0.6 per cent
  (2.5 per cent annual – nine year low); the weighted median rose by 0.5 per cent (2.3 per cent – near five year low) and we estimate at that CPIX rose 1.0 per cent (2.9 per cent).
• The “underlying” measures of inflation rose on average by 0.65 per cent in the September quarter, dragging the annual rate down from 2.7 per cent to a 3-year low of 2.6 per cent.
• The bottom line is that the Reserve Bank will be hard pressed to justify a rate hike next week. CommSec expects rates to remain on hold next week.

What does it all mean?

• Three months ago we described the inflation figures as a beautiful set of numbers. Well the latest result is even better. Inflation was well below economist forecasts in the September quarter and underlying inflation is even below where the Reserve Bank expected it to be. The bottom line is that the Reserve Bank will be very hard pressed to justify a rate hike – not just in November but at least to February 2011.
• Low inflation is in everyone’s interests. It shows that the economy is functioning well and allows interest rates to remain at current levels, allowing consumers and companies to get on with business.
• The simple fact is that consumers are conservative and are refusing to spend unless goods are on special. As long as consumers remain conservative and businesses have to shave margins to move stock then inflation will remain low as will interest rates.
• The absence of significant price pressures indicates that the economy is softer than the Reserve Bank has assumed. Certainly the good inflation numbers have justified the decisions to leave rate settings on hold over the past few months.

• The Reserve Bank has to be forward looking. And it is still likely that inflation will pick up in the future in line with the economy and interest rates may also need to rise. But today’s results show that the Reserve Bank has time on its hands. It could very well be that the Reserve Bank will downgrade its inflation forecasts for the coming year, not move them higher.
• The only people that will be disappointed at today’s results are those who were hoping that an interest rate increase would boost the returns on their term deposits and other investments
• The $64 question is how long the Reserve Bank can stay on the interest rate sidelines. The short answer is: for as long as inflation stays in the 2-3 per cent target band. Given the latest round of data it is unlikely that the Reserve Bank will be raising interest rates next week. In fact rates are more likely to stay on hold until early in 2011. A lot will depend on the updated inflation forecasts that are released by the central bank in the Statement on Monetary policy on November 5.
• In the midterm we expect that the strong job market and record wealth levels would entice consumers to spend again however it is unlikely to have a dramatic impact until well into 2011, meaning that rates will rise over the next 12 months.

What do the figures show?

• The All Groups Consumer Price Index (CPI) rose by 0.7 per cent in the September quarter after rising by 0.6 per cent in the June quarter.
• Higher prices for tobacco, water and sewerage, electricity, property rates and rents were partially offset by lower prices for petrol, vegetables, electrical goods and pharmaceuticals.
• The ABS notes that “The most significant price rises this quarter were for tobacco (+7.0%), water and sewerage (+12.8%), electricity (+6.0%), property rates and charges (+6.2%) and rents (+1.1%). The most significant offsetting price falls were for automotive fuel (–3.7%), vegetables (–5.4%), pharmaceuticals (–3.9%), audio, visual and computing equipment (–2.7%) and soft drinks, waters and juices (–1.8%)”.
• The annual rate of inflation fell from 3.1 per cent in the June quarter to 2.8 per cent in the September quarter.
• Underlying measures of inflation were up modestly in the September quarter. The weighted median measure rose by 0.5 per cent in the quarter, with the annual rate falling from 2.7 per cent to 2.3 per cent – a nine year low. The trimmed mean measure rose by 0.6 per cent in the quarter with the annual rate falling from 2.7 per cent to 2.5 per cent – a near 5 year low. And CommSec estimates that the CPI excluding fruit, vegetables, petrol and deposit and loan facilities (CPIX) rose by 1.0 per cent in the quarter with the annual rate rising from 2.8 per cent to 2.9 per cent.
• Prices of tradables rose by 0.2 per cent in the September quarter, with higher prices for tobacco, and furniture partially offset by cheaper fruit, vegetables and petrol. The annual growth rate of tradables remained steady at 1.4 per cent.
• Prices of non-tradables rose by 1.1 per cent in the September quarter. Price increases for water and sewerage, electricity, house purchase, and gas were offset by price falls for telecommunications, jams, eggs and poultry. The annual rate of non-tradables inflation fell from 4.2 per cent in the June quarter to 3.8 per cent in the September quarter.
• Tradable goods are those items whose prices are largely determined on the world market. Non-tradable prices are more affected by domestic economic conditions.

What is the importance of the economic data?

• The Consumer Price Index (CPI) is regarded as Australia’s premier measure of inflation. The CPI is published quarterly and measures price changes for a ‘basket’ of goods and services that dominate expenditure of metropolitan households. The “All Groups” index is the main focus, but other inflation measures are also published such as so-called ‘underlying’ measures. These include measures that abstract from price changes in volatile price items such as fresh food and petrol.
• The Reserve Bank aims to keep the headline inflation rate between 2-3 per cent over an economic cycle. If inflation is high and expected to rise, the Reserve Bank may elect to raise interest rates in order to constrain price pressures. Conversely, if inflation is low and expected to remain low, the Reserve Bank may elect to cut interest rates if it believes the growth pace of the economy is in need of strengthening.

What are the implications for interest rates and investors?

• If homebuyers are looking for someone to thank for interest rates remaining on hold, they can give themselves a pat on the back as well as retailers. People haven’t been spending, so retailers have had to cut prices to move stock. It remains to be how long shoppers will stay on the sidelines though.
• The job market is healthy, wages are higher and wealth is back at record highs, so there are good reasons for consumers to spend again in the lead up to Christmas and into the New year.
• A sustained period of interest rate stability will be the key driver in supporting activity in the near term. Consumers are still shell shocked from the global financial crisis and rapid fire rate hikes. People will start spending again once they believe the environment is more settled.

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