Interpac Business and Migration Solutions Melbourne Australia

(September.5 2011)

Australia posted a month of deflation for the first time in nearly two years in August even as hopes dim for an interest rate cut when the Reserve Bank meets tomorrow.

Inflation slipped 0.1 percentage point in August from a 0.3 per cent rise in July according to the TD Securities - Melbourne Institute monthly inflation gauge. It was the first decline in the reading since October 2009.

On an annual basis, inflation rose by 2.9 per cent in August, slowing from a 3.2 per cent pace in July, and easing back into the RBA's preferred 2 per cent to 3 per cent range.

The monthly inflation rate was dragged lower by cheaper fruit and vegetable prices as growers recovered from the summer's floods and cyclones. The price of fruit and vegetables fell by 1.6 per cent in August, following a 1.8 per cent rise in July.

Even with the extra room to move, though, economists and investors expect the central bank to leave the key cash rate on hold at 4.75 per cent when the RBA's board meets tomorrow. The overall economy is patchy but there's enough of an investment bulge coming from the reignited mining boom to keep upward pressure on inflation.

"We believe policymakers cannot entirely ignore inflation risk, even after the financial market turmoil of late," said Nomura International economist Stephen Roberts. "The RBA has some capacity to stay on policy hold for a while longer."

Credit markets were this morning pricing in a one-in-five chance of a rate cut when the RBA meets tomorrow, well down from the bet that the RBA would slash 50 basis points from the cash rate tipped by investors during the steepest of the market plunges in the second week of August.

Outlook divided

Those jitters continue to play out with local stocks opening as much as 1.8 per cent lower today, adding to Friday's 1.5 per cent retreat. Investors, for instance, are still tipping 1.25 percentage points of rate cuts in 12 months' time, which would take the cash rate to 3.5 per cent, according to Credit Suisse data.

A number of banks have lowered their fixed interest rate loans in recent weeks to attract new borrowers, despite the cash rate being unchanged at 4.75 per cent since November.

Economists remain divided over the outlook for official rates in coming months with some, such as TD Securities, believing the RBA will lift interest rate once in the first quarter of 2012.

Nomura Internation also believes the RBA will lift rates to 5 per cent in February 2012 to counter the inflation stemming from the resources investment.

In a sign of the conflicting forces at work in the global economy, other economists, such as Westpac chief economist Bill Evans, see as much as 1 percentage points of interest rate cuts over the next year as the central bank responds to a slowing local economy, persistently weaker consumer confidence, and continued ructions on global markets.

A 25-basis-point cut to the cash rate, if passed along in full by banks, would lop about $48 from the average monthly repayment cost on a typical 25-year, $300,000 loan.