October 25, 2016 07:30 CDT

Consensus Actual Previous
Quarter over Quarter 0.5% 0.7% 0.4%
Year over Year 1.1% 1.3% 1.0%
Trimmed mean - Q/Q 0.4% 0.4% 0.5%
Trimmed mean - Y/Y 1.7% 1.7% 1.7%
Weighted Median - Q/Q 0.4% 0.3% 0.4%
Weighted Median - Y/Y 1.4% 1.3% 1.3%

Headline CPI inflation in Australia picked up by more than expected in the three months to September, though measures of underlying inflation were unchanged. This will likely reinforce the view of officials at the Reserve Bank of Australia that inflation will increase towards its target range over the medium term and suggests there is little chance of another rate cut at the RBA's next policy meeting next week.

The headline consumer price index increased by 0.7 percent on the quarter, stronger than the consensus forecast of 0.5 percent, and up from an increase of 0.4 percent in the three months to June. This is the strongest quarterly gain in the index since mid-2015. Annual inflation also recorded a solid increase from 1.0 percent in the three months to June, its lowest level since 1999, to 1.3 percent in the three months to September, above the consensus forecast of 1.1 percent.

The increase in headline inflation was largely driven by stronger price rises for food and non-alcoholic beverages, with the annual inflation rate for this category of spending increasing from minus 0.1 percent in the three months to June to 1.5 percent in the three months to September. Prices also rose at a faster rate for housing, clothing and footwear, furnishings, household equipment and services, and insurance and financial services. Stronger price pressures, however, were not evident in all categories of spending, with inflation rates unchanged for education and falling for health, transport, recreation and culture, alcohol and tobacco, and communication.

The impact of higher food prices was less pronounced on measures of core inflation which exclude the impact of volatile price changes. These measures suggest that underlying price pressures remained subdued. The trimmed mean CPI inflation measure was unchanged at 1.7 percent in three months to September, while the weighted mean CPI inflation measure was also unchanged at 1.3 percent. The average of these two measures in the three months to September, around 1.5 percent, is broadly in line with the RBA's forecast for underlying inflation at the end of 2016.

Despite the strong increase in the CPI in the three months to September, headline inflation remains well below the RBA's target range of 2.0 percent to 3.0 percent. The RBA has cut policy rates twice this year, and both of these cuts took place at the policy meeting immediately following the release of quarterly CPI data that showed low inflation. The RBA's next meeting is scheduled to take place on Tuesday November 1.

Ahead of today's data, markets were pricing in little chance of a rate cut at the RBA's meeting next week. RBA Governor Philip Lowe last week expressed confidence that inflation would return "close" to its target over the next two years and has also stressed in recent comments that the RBA has a "flexible" and patient approach to meeting its inflation target.

Although underlying measures were unchanged in the last quarter, today's data showing a pick-up in headline inflation will likely reassure officials their forecasts for inflation to move back towards target are on track. This supports the market view that the RBA will likely keep policy settings on hold at its meeting next week. Revised forecasts will also be published in the the quarterly Statement of Monetary Policy scheduled for release late next week.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by households for a fixed basket of goods and services. The data are released quarterly. In Australia, the CPI measures the changes in the price of a fixed basket of goods and services, acquired by household consumers who are residents in the eight State/Territory capital cities. (Darwin, Perth, Sydney, Melbourne, Hobart, Brisbane, Canberra and Adelaide)

The consumer price index is the most widely followed indicator of inflation. An investor who understands how inflation influences the markets will benefit over those investors that do not understand the impact. In countries such as the Australia, where monetary policy decisions rest on the central bank's inflation target, the rate of inflation directly affects all interest rates charged to business and the consumer.

Inflation is an increase in the overall prices of goods and services. The relationship between inflation and interest rates is the key to understanding how indicators such as the CPI influence the markets - and your investments. Inflation (along with various risks) basically explains how interest rates are set on everything from your mortgage and auto loans to Treasury bills, notes and bonds. As the rate of inflation changes and as expectations on inflation change, the markets adjust interest rates. The effect ripples across stocks, bonds, commodities, and your portfolio, often in a dramatic fashion.

By tracking inflation, whether high or low, rising or falling, investors can anticipate how different types of investments will perform. Over the long run, the bond market will rally (fall) when increases in the CPI are small (large). The equity market rallies with the bond market because low inflation promises low interest rates and is good for profits.

Unlike most other countries, Australia calculates its CPI on a quarterly basis. For monetary policy, the Reserve Bank of Australia generally follows the annual change in the consumer price index. It has an inflation target of 2 percent to 3 percent. The RBA also has two preferred core or analytical measures - the weighted and trimmed means. The trimmed mean is a method of averaging that removes a small percentage of the largest and smallest values before calculating the mean. After removing the specified observations, the trimmed mean is found using an arithmetic averaging formula. The weighted mean excludes certain items from the CPI basket (the exclusion approach). Typically, the excluded items are those that are volatile and/or display pronounced seasonal patterns, and those that are subject to administrative price setting.

Currency traders prefer healthy growth and higher interest rates. Both lead to increased demand for a local currency. However, inflationary pressures put pressure on a currency regardless of growth. For example, if the Australian Bureau of Statistics reports that the consumer price index has risen more than the RBA's 2 percent to 3 percent inflation target, demand for the Australian dollar could decline. Similarly, when the RBA lowers interest rates, the currency weakens. (Currency traders also watch the interest rate spread between countries.)