Inflation Indicator Drop

TD-MI's inflation indicator showed a 0.3% drop in consumer prices in October. This brought their annual inflation rate down to 1.2% from 1.3% previously. The components with the largest downward influence on prices were private motoring, fruit and vegetables and financial services. These price falls were offset by gains in prices for holiday travel and accommodation, meals out and takeaway foods, and books, newspapers and magazines.

The Australian Government upgraded its economic and fiscal outlook versus that posted in May, given better-than-expected domestic economic activity and improving prospects for the global economy. The Government now expects the unemployment rate to peak at 6.75% versus the 8.5% rate projected for 2010/11. It also projects that this peak could occur earlier, i.e. in 2009/10. In terms of GDP growth, for 09- 10 this has been upgraded to be at 1.5% and then improve to 2.75% and 4.0% in the following fiscal years.

Despite the upgrades, however, the forecasts fall short of the RBA's expectation for 3.25% growth in 2010/11 (the central bank is expected to update this assessment on Friday). The average price for established houses in Australia's eight capital cities (detached houses only, excluding townhouses, terraces and units) jumped 4.2% in the September quarter, matching the increase in the June quarter. In annual terms, house prices moved back into positive territory (+6.2) after three consecutive quarters of contractions. All of the eight capital cities posted strong house price growth in the quarter. But the star performers were Melbourne, Perth, Brisbane, Sydney and Canberra, where prices were up 4.0% - 5.0%.

Looking ahead, in the short term, further gains in house prices could be dampened by expected further increases in the unemployment rate, interest rate to be at 2.25% in the next three fiscal years. increases and the end to the First Home Owners Boost (FHOB). But strong population growth, i.e. the pent up demand for housing, an undersupply of dwellings and the currently underway recovery in the domestic economy towards its long-term potential should still provide key support over the medium term.

The RBA meets today on interest rates with the decision due at 2.30pm AEST. We still stick with our call for a 25bp rate hike. Monetary policy had been loosened to very accommodative levels earlier this year to guard against the risk of very weak economic conditions and a possible recession. But the Australian economy has certainly fared better than what most had been expected so some of this accommodation has to be removed to be more in line with the current environment. But we think it is unlikely that the RBA will move aggressively by delivering an aggressive 50bp rate hike.