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Australian markets rally on low inflation data

SYDNEY: Australian markets rallied on Tuesday when the inflation rate for the March quarter came in well below expectations on Tuesday but caution remained ahead of key wages data due on Wednesday.

While inflation at the beginning of 1996 remained well under control and eased the pressure for a near term interest rate rise, wages growth was seen as still the key factor in determining whether or not rates will have to rise in 1996.

The consumer price index (CPI) rose only 0.4 percent in the March quarter, well under forecasts of a 0.7 percent rise as the effects of slower economic growth and some reduction in taxes in the state of Victoria reduced price pressures.

The smaller than expected CPI rise took the annual inflation rate down to 3.7 percent, its lowest level since December 1994.

For financial markets, the number that saw bond and bill yields rally was the key underlying rate which also rose 0.4 percent in the quarter, against a forecast 0.7 percent rise.

By the end of trading on Tuesday, 10-year bond yields had fallen 12 basis points to 8.76 percent, and the stock exchange had risen 32.6 points, or 1.44 percent, to 2300.00.

"It is a fantastic number for the Reserve Bank," Dresdner Australia chief economist Rob Henderson said.

The rise took annual underlying inflation to 3.3 percent. The Reserve Bank of Australia (RBA) aims to keep the underlying rate to an average of two to three percent over a run of years.

As such, the fact the underlying rate is above three percent does not represent a breach of this target. Economists were in fact bouyed by the result, as the March quarter was expected to be the peak in the underlying rate

"It was a great result for taking pressure off interest rates," Hongkong Bank economist Anthony Thompson said.

"It's showing that the peak in the underlying annual rate is lower than the RBA thought it would be," he said.

Last week, the RBA said it expected underlying inflation to peak at around 3.5 percent in March, before heading back under 3.0 percent in the second half of the year.

However, economists said the March figures meant underlying inflation could well be back under three percent by the June quarter, and be well under three percent by the end of 1996.

"Suspicions that Australian inflation would stay well above the RBA's two to three percent target for many quarters are proving to be unfounded," Citibank Australia chief economist Grant Bailey said.

While markets rallied strongly on the data, gains were capped by caution ahead of key wages data due on Wednesday.

"Although today's figure showed that inflation has been well contained, it is prospective inflation with which the markets are preoccupied," Bankers Trust economist Peter Munckton said.

The Reserve Bank, as recently as last Friday, has warned that wages growth poses the biggest threat to inflation, and further increases in the rate of wages growth will leave them with no alternative but to increase rates.

Economists expect wages to have risen by 1.0 percent in the first quarter, keeping annual growth steady at around 4.9 percent. After Tuesday's data, a figure in line with forecasts or lower would be bullish for markets, economists said.

Not only are wages causing concern, but the prospect of stronger growth later in 1996 concerned some economists.

"It all has a very temporary look about it," said Stephen Roberts, chief economist at UBS Australia.

"The risks are that both underlying inflation and headline inflation get very sticky and may even turn back up again," he said.-Reuter