Inflation jump puts a Melbourne Cup Day rate rise on the cards

Borrowers are bracing for an interest rate rise on Melbourne Cup Day, with financial markets pricing about a 90 per cent chance that the Reserve Bank lifts the cash rate when its board hands down its decision at 2:30pm on Tuesday.^[1] A rise of 0.25 percentage points would take the cash rate to 4.85 per cent from 4.60 per cent, its fifth increase this year.^[2][4]

The trigger was Wednesday's inflation figures. Annual inflation rose to 4.3 per cent in September from 4 per cent in August, well above the RBA's target band of 2 to 3 per cent, as housing costs rose 5.2 per cent over the year and fuel prices rose 9.4 per cent in September.^[3]

Underlying inflation is moving the wrong way

The figure the RBA watches most closely, the trimmed mean, rose to 3.6 per cent, even though it strips out volatile items such as fuel. Over the September quarter it rose 1 per cent.^[3] "Back in August, the RBA forecast a trimmed mean quarterly gain of 0.8 per cent in the September quarter, so today's 1.0 per cent quarterly gain is confirmation that those inflation risks have indeed materialised," Betashares chief economist David Bassanese said.^[3]

KPMG chief economist Brendan Rynne called the figures "the last data point necessary for the RBA to increase the cash rate for a fifth time this year". "It is clear pricing pressures in the Australian economy are growing, not weakening, and the upswing in inflation is catching the market off guard," he said.^[3] Deputy governor Andrew Hauser told Senate estimates on Wednesday that inflation was broadly in line with the bank's expectations but too high, a week after warning the outlook looked "materially worse" than forecast.^[3] Commonwealth Bank economists now expect a rise to 4.85 per cent.^[4]

What comes after Tuesday

Few economists see Tuesday as the end of it. Mr Bassanese's base case is a rise next week followed by a hold in December, a pre-Christmas reprieve for households. "Should rates need to rise even further next year, the risk of recession would no doubt intensify," he said.^[3] Former NAB chief economist Alan Oster told the ABC it may take three more rate rises to calm inflation, a scenario he said would also produce a recession.^[1]

AMP economists Diana Mousina and My Bui said the RBA had little room to wait. "If the RBA doesn't raise rates next week, then their credibility could take a hit and embed higher inflation expectations further," they wrote.^[3] The board will also publish updated forecasts for inflation and growth with Tuesday's decision.^[3]