ANALYSIS: Will inflation spark an interest rates hike?

Inflation has risen ahead of market expectations, thanks to natural disasters and overseas political uncertainty. Finance Editor Tiffany Hutton asks whether this will put upward pressure on interest rates.

As expected, the Australian Bureau of Statistics (ABS) has announced that the Consumer Price Index rose in the March quarter, up 1.6 per cent compared with a rise of 0.4 per cent in the December 2010 quarter, bringing the annual CPI for the year ended March 2011 to 3.3 per cent.

Both figures were slightly higher than many economists had predicted, but the sources of the jump were no surprise.

Fuel was up 8.8 per cent, fruit and veg were both significantly higher (14.5 per cent and 16 per cent respectively), and pharmaceuticals up 12.5 per cent.

According to the ABS, this is the largest quarterly rise in the CPI since June quarter 2006 when the CPI increased 1.6 per cent.

The economic fall-out from the recent natural disasters was certainly seen in food prices, while continuing unrest in the Middle East pushed up oil.

Some prices have come down, however, including AV and computer equipment (7.2 per cent drop), furniture (down 6.2 per cent) and — thanks to the supermarket milk wars — milk fell 6.2 per cent.

So will this increase in CPI be enough to provoke an interest rate rise from the RBA?

Probably not immediately.

That's because it's not just the CPI that is considered when the Reserve Bank of Australia (RBA) does its sums.

Indeed, the RBA was expecting these inflationary pressures — the increased food prices especially — and they are essentially short-term ‘blips’ that should be largely back to normal in the next quarter.

The underlying inflation rate, generally the more important indicator from a monetary policy perspective, is still at 2.25 per cent, comfortably within the RBA’s target range of 2–3 per cent.

However, with unemployment low, it’s increasingly likely that the RBA will have to lift rates in the second half of the year.

Interestingly enough, slightly less than a year ago the OECD was predicting that Australia’s official interest rates would be up to 5.7 per cent by now.

It’s worth noting that the ABS also recently reviewed the CPI and changes are afoot, starting in the September quarter of this year.

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