Price data raises risk of rate hike

SYDNEY - Australian factory gate prices increased at their fastest pace in six years last quarter, heightening concerns that rising production costs could feed into consumer inflation and force another hike in interest rates.

Yesterday's report showed producer prices for final goods climbed 1.6 per cent in the second quarter, well above forecasts of a 1.1 per cent rise.

Prices were 4.5 per cent higher than a year earlier, the highest reading since 2000.

Such strength aggravated fears the consumer price (CPI) report tomorrow would show enough inflationary pressure to draw a precautionary rate rise from the Reserve Bank of Australia at its policy meeting next week.

"We think the Reserve Bank is likely to lift rates next week," said Su-Lin Ong, senior economist at RBC Capital Markets. "It would take an extraordinarily good CPI to stop them because what today's numbers show is that there are pressures in the pipeline and, even if the CPI does surprise on the downside, there is still risk going forward," she argued.

The markets seemed to agree, with bonds sliding in the wake of the data. Interest rate futures showed a 90 per cent chance of a hike to 6.0 per cent after the central bank's policy meeting on August 1. They also narrowed the odds of yet another move after that.

The cost of oil was again the main culprit behind the jump in second-quarter producer prices, with petrol up 20 per cent in the quarter.

But even after stripping that out, the core price index was still up 1.0 per cent, while manufacturing and construction costs showed significant increases.

There was also further evidence of a squeeze on profit margins, with the prices paid by manufacturers for their material inputs up by 18.1 per cent in the year, while the prices they received increased by 9.9 per cent.

"The PPI was stronger than expected and at a core level, suggests we are seeing some catch-up in goods prices from earlier inflation pressures," said Scott Haslem, chief economist at UBS.

"At first look, today's data is consistent with a further RBA rate hike as insurance to ensure future inflation remains contained."

Analysts were already looking for consumer price inflation to hit its highest level in over three years.

Median forecasts are for a rise of around 1.0 per cent in the second quarter, driven by surging petrol costs, fruit and vegetable prices and annual increases in health insurance.

That would take inflation for the year to 3.4 per cent and out of the central bank's 2-3 per cent target zone.

Just as critical for interest rates will be what the RBA's own statistical measures of underlying inflation show.

Analysts are uncertain about the outcome after being surprised by their strength in the first quarter.

Forecasters generally see rises of 0.8 per cent in the RBA's trimmed mean and weighted median measures.

That would leave annual underlying inflation steady at around 2.75 per cent, although that might not be enough to stay the RBA's hand given recent surprising strength in employment, credit and consumption.

"A rate rise is necessary, not only on the hard evidence that inflation is accelerating, but also on concern that future inflation is building on the back of historical low unemployment, a rebound in housing activity and buoyant global conditions," argued Stephen Koukoulas, chief strategist at TD Securities.

- REUTERS