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Soft producer prices add to rate cut case

Producer prices rose by far less than expected last quarter as a lofty local dollar and falling petrol prices helped offset the impact of a carbon tax, a benign outcome that adds to the case for a cut in interest rates next week.

Prices at the final stage of demand (PPI) rose 0.6 per cent in the third quarter, just half what analysts had forecast. Annual inflation stayed at a low 1.1 per cent, instead of picking up to 1.6 per cent as expected.

The tame result could reassure the Reserve Bank of Australia (RBA) that a spike in consumer inflation seen last quarter was not the start of an acceleration in price pressures.

"It's a good signal that the outlook for inflation is still contained," said Michael Workman, a senior economist at Commonwealth Bank of Australia. "We are leaning toward a cut in rates next week and this result only reinforces the call."

The RBA meets on November 6 and markets are divided on whether it will follow October's rate cut with another quarter point move to 3 per cent, so equalling the record lows reached during the global financial crisis.

Investors had trimmed expectations of how far and fast rates might fall when the consumer price index (CPI) rose by a surprisingly hefty 1.4 per cent in the third quarter, lifted by the carbon tax and a government change to health insurance.


Annual underlying inflation picked up to 2.5 per cent, from 2.1 per cent, taking it back to the middle of the RBA's long-term target range of 2 to 3 per cent.

Interbank futures now show a 42 per cent chance of a cut next week, while swap rates imply a probability of 52 per cent. Yet a move to 3 per cent is still fully priced in by Christmas, with 2.75 per cent tipped for next year.

The RBA has already cut rates by 100 basis points since May, citing slower global growth, a softer labour market at home and falling prices for some of Australia's major resource exports.

the impact of the carbon tax was again apparent in utilities prices which climbed 10.9 per cent in the third quarter at the producer level. Poor growing conditions also led to a 25 per cent jump in prices for some farm products.

That contributed to a 0.8 per cent increase in overall domestic producer prices for the quarter.

In contrast, prices for imported products fell a sharp 2.3 per cent in the third quarter, thanks in part to a 10 per cent drop in petrol costs and a strong Australian dollar.

But while the lofty dollar has been invaluable in restraining inflation, it has been much more painful for trade exposed sectors such as manufacturing and tourism.

The central bank has all but ruled out large scale intervention to bring the currency down, suspecting it would not work in any case. Yet RBA Deputy Governor Philip Lowe this week did note that, in general, a strong currency meant interest rates could be lower than otherwise.

"Despite the fall in commodity prices, lower local interest rates and slower domestic growth, the dollar has remained high," said Paul Bloxham, an economist at HSBC Australia. "So the currency appears to have become less of a shock absorber for the economy than it has been in the past."

As a result he expects another cut in rates by year-end, and likely next week.