Market Update

Thursday, October 27 2011

Australian Inflation better than expected

While headline inflation was in-line with expectations on the quarter (0.6%), the two primary measures of core inflation (trimmed mean and weighted median) were significantly below expectations at 0.3% versus consensus at 0.6%. This was the lowest quarterly growth since 2000 and has brought the year-on-year growth rate into the lower half of the RBA target range. The market now expects that the RBA will cut rates in each of the next three meetings (November, December and February).

The RBA has made it clear that if the inflation rate was contained that they were likely to lower rates.  This in addition to a pullback in iron ore prices increases the flexibility for the RBA.

Broadly positive for equity markets

An improved inflation outlook that leads to a rate cut would be broadly positive for the equity market. History has shown that the banks respond first and hardest to a rate cut but it will take a few months to filter through to other sectors (consumer, media, transport and property). We would also expect this to boost consumer sentiment over the coming months.  We note a number of sectors which would historically benefit from a rate cut have been heavily shorted in the past six months.  We have increased our exposure to banks and domestic cyclicals over the past quarter and while this was probably a little early we would expect to see benefits in the coming months.

 

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