Economy

Prices rose more strongly than expected in the June quarter, and more disturbingly, underlying inflation did likewise, leaving the Reserve Bank with an interest rate dilemma: will the RBA's inflation fighters be forced to put up interest rates against a backdrop of global upheaval over debt?

 June quarter inflation rose 0.9%, leaving the annual rate at 3.6 per cent. The biggest increases came from fruit, especially bananas, the medical sector, petrol, and clothing and footwear. More importantly these increases can’t be blamed on the devastating Queensland and Victorian floods and cyclone Yasi’s impact on food prices. The Reserve Bank's measure of underlying inflation was also up by a stronger than expected 0.9 per cent, suggesting the price pressures are more broad-based.

This raises serious concerns for the RBA, as they see that inflation is picking up at a faster pace than even the RBA thought at this point of the cycle. Today’s result saw talks of a rate cut subside, but not totally disappear.

With the RBA board meeting on Tuesday we are sure to hear their views which will provide greater clarity on the direction of monetary policy. If the rhetoric in that statement really starts to sort of show increasing concern about the inflation outlook, then I would expect the market will no longer be pricing in some chance of a rate cut before year end.

At the end of the day, if the domestic considerations and higher inflation win out, then they are likely to deliver a hike at the end of the year, as with so much global uncertainty around this should keep the RBA on the sidelines for a bit longer.

The foreign exchange traders weren't waiting around. The prospects of higher interest rates sent the Australian dollar above 110 US cents to a new 29-year high.