Inflation hike heralds election rate rise

The chances of an unprecedented election campaign interest rate rise are now very high after quarterly CPI figures released today show underlying inflation breaching the 2-3 per cent tolerance band set by the Reserve Bank.

Although the headline figure for the CPI in the third quarter came in at 0.7 per cent – giving an annual rate of inflation of just 1.9 per cent in the year to September – the RBA prefers to look at adjusted measures of inflation which take out volatile items and one-off price movements.

The two adjusted measures it uses don't make for pretty reading, now at 2.9 per cent and 3.1 per cent, up from 2.8 per cent. These figures weigh more importantly than any other in the minds of the members of the Reserve Bank board in considering interest rates – curbing inflation is their key priority in setting rates.

The latest inflation reading suggests that the economy is struggling to contain prices in the wake of solid economic growth this year and capacity constraints which don't allow businesses to raise supply to the levels necessary to meet demand. The wholesale or producer price index released earlier this week told a similar story.

The RBA board meets in less than two weeks – on Melbourne Cup Day – to consider interest rates. It will have to assess how much these latest CPI figures threaten an inflation breakout and weigh that risk against the possibility of recession in the United States and the hit to business activity in Australia from the fallout from the US sub-prime lending debacle, which is already nudging up interest rates around the world.

It would be a brave move to raise rates during the heat of an election campaign, something never done in living memory, although the RBA only took over responsibility for setting rates from the government of the day in 1996. RBA governor Glenn Stevens however said earlier this year elections would have no bearing on interest rate deliberations.

Borrowers on variable rate mortgages should prepare for a rise of 0.25 per cent in their interest rate in November, lifting repayments by $17 a month for every $100,000 borrowed.