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Today's September quarter inflation print was a little above market expectations, but the surprise is insufficient to alter the likely outcome of next week's RBA decision; we still expect a 25bp rate hike next Tuesday. A very low outcome today could have triggered second thoughts by RBA Board members for next week, while an unexpectedly high core result might, at a stretch, have got them thinking about a 50bp move. This inflation result, though, will not rock the RBA's boat, so Board members will deliver on market expectations for a modest rate hike next Tuesday. Indeed, even if Board members do think (briefly) about delivering 50bp, they will decide against scaring the horses on Melbourne Cup day.

We expect another 25bp hike in December, and a further move in February after the first Board meeting of 2010. Indeed, the arguments in favour of the steady removal of the "emergency" component of the RBA's current policy setting remain compelling, but an orderly exit is prefereable to a stampede. The RBA is removing the "insurance"component of the accommodative policy setting because the downside risks that loomed large earlier this year have receded further into the background.

RBA officials clearly are, however, anxious about the medium term inflation outlook, with last week's Board minutes indicating that the trough in inflation will be significantly higher than previously thought. Officials, therefore, want to push the policy setting closer to normal before the inflation problem becomes even more acute. There is, however, no rush, particularly so with other major central banks sitting on the policy sidelines.

In Q3, the headline CPI printed above expectations at 1.0%q/q (J.P. Morgan 0.7%q/q, consensus 0.9%q/q), after a 0.5% rise in Q2. This nevertheless dragged the annual rate of headline inflation down slightly to 1.3%oya, well below the lower band of the RBA's 2-3% target range. The biggest contributors to headline inflation in the September quarter were an 11% rise in electricity prices, a 4% rise for automotive fuel, a 14% rise for sewerage and water, a 3% rise in deposit and loan facilities, and a 1% rise in house purchase costs. Partly offsetting these rises were a 6% drop in vegetable prices, a 5% fall for fruit, a 4% fall for pharmaceuticals, and a 2.2% fall for electronics, mainly reflecting the impact of higher AUD. Indeed, tradables inflation got a free kick from the rising AUD - imported inflation rose just 0.2%q/q (0.5% over the year), while the domestic component rose 1.5%q/q.

The all-important trimmed mean measure of core inflation also printed above expectations at 0.8%q/q (J.P. Morgan and consensus 0.7%), and 3.2%oya. The alternative weighted median core measure printed in line with expectations at 0.8%q/q. On our forecasts, core inflation will trough near the top of the RBA's target range in the first half of 2010. On the evidence to hand, RBA officials have failed to squeeze inflation from this economy, despite having had the advantage of an extended period of sub-trend GDP growth. This means we are starting the next cyclical upswing in the economy with an uncomfortably high rate of underlying inflation. In this environment, with the inflation outlook also deteriorating, we need to prepare ourselves for what will be an extended tightening cycle.

The next important policy milestone is Governor Glenn Stevens' speech next Thursday, the evening before the RBA releases the November quarterly statement. The statement will include upgrades to both the official growth and inflation forecasts. Based on the hint delivered in last week's Board minutes, we believe the statement will push the medium term core inflation forecast up to 2.75% (at least), from the current 2%. With the Board minutes also indicating that inflation will be accelerating in 2011, the RBA will continue tightening policy through 2010, albeit at a more measured pace than the urgency at which the "emergency" component is being removed.

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