January 24, 2017 06:30 CST

Consensus Actual Previous
Quarter over Quarter 0.7% 0.5% 0.7%
Trimmed mean - Q/Q 0.5% 0.4% 0.4%
Weighted Median - Q/Q 0.5% 0.4% 0.3%
Year over Year 1.6% 1.5% 1.3%
Trimmed mean - Y/Y 1.5% 1.6% 1.7%
Weighted Median - Y/Y 1.5% 1.3%

Headline CPI inflation in Australia rose to 1.5 percent in the three months to December, up from 1.3 percent in the three months to September and just below the consensus forecast of 1.6 percent. Although this increase is consistent with officials' view that price pressures are likely to strengthen gradually, headline inflation remains within its recent range and below the Reserve Bank of Australia's target range of 2.0 percent to 3.0 percent. Measures of underlying inflation, meanwhile, were mixed in the three months to December, suggesting there is not a clear case for a change in policy rates when the RBA holds its next policy meeting early next month.

The small increase in headline inflation in the three months to December reflects mixed results in the various categories of consumer spending. Prices rose at a faster year-on-year pace for food and alcoholic beverages, housing, and transport, but decelerated for clothing and footwear, health, and furnishings, household equipment and services. Overall, price pressures remain relatively subdued, with headline inflation now right at the mid-point of the range of 1.0 percent to 2.0 percent that has prevailed since the start of 2015.

In quarter-on-quarter terms, the headline consumer price index increased by 0.5 percent in the three months to December, down from 0.7 percent in the three months to September and weaker than the consensus forecast of an increase of 0.7 percent. This largely reflects a smaller increase in the price of food and non-alcoholic beverages, which rose 0.6 percent after an increase of 1.7 percent the previous quarter. Housing costs also grew at a slower pace in the three months in December. This was partly offset by a bigger increase in transport costs, reflecting higher fuel prices.

Measures of core inflation, which exclude the impact of volatile price changes, were mixed in the three months to December, but also suggest that underlying price pressures remained subdued. The trimmed mean CPI inflation measure fell from 1.7 percent in the three months to September to 1.6 percent in the three months to December, while the weighted mean CPI inflation measure rose from 1.3 percent to 1.5 percent. Both measures of inflation rose 0.4 percent quarter-on-quarter.

With inflation still contained and below target, the policy bias for the RBA likely remains in favour of additional rate cuts, particularly given the contraction in gross domestic product recorded in the three months to September. Nevertheless, the RBA has now held policy rates unchanged since August, and today's inflation data - showing an increase in the headline rate and mixed results in underlying measures - suggest that there is not clear case for any change in policy at the February meeting. Officials may instead prefer to wait to see whether GDP data for the three months in December -scheduled for release in early March - shows a rebound in growth before deciding whether further policy easing is warranted.

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.)