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Rate-Cut Bets Ended as Faster Inflation Beats Slowdown: Australia Credit

Australia’s fastest inflation since 2008 means Reserve Bank Governor Glenn Stevens will maintain the developed world’s highest borrowing costs even as evidence mounts the economy will slow, money markets show.

Two-year government bond yields climbed 13 basis points to 4.50 percent yesterday, the biggest jump since Feb. 4, as a report showed consumer prices surged an annualized 3.6 percent last quarter. Yields on September cash-rate futures rose the most in three months to 4.75 percent, matching the RBA benchmark, as traders ended bets on a cut in borrowing costs.

The Australian dollar soared to a post-float record and has climbed 23 percent against the greenback in the past year as a mining-investment boom drove unemployment below 5 percent. Inflation expectations, which had been declining on concern European and U.S. debt crises will roil global markets, gained as yesterday’s data showed measures that strip out volatile prices such as food and energy exceeded economists’ forecasts.

“The RBA is in an awkward position because inflation is rising, the domestic economy looks like it’s slowed a bit and there are also a number of global risks,” said Paul Bloxham, Sydney-based chief economist for HSBC Holdings Plc and a former RBA official. “They’ll sit on their hands next week, but I still think the next move is up.”

Yields on September cash-rate futures had dropped to 4.55 percent on July 12, signaling a 78 percent chance of a rate cut. December contracts showed a 6 percent chance of lower borrowing costs by year-end as of 8:44 a.m. in Sydney, down from a 100 percent chance on July 25.

Debt Rally

Stevens said earlier this month the RBA may lower its 2011 growth forecast. Australian government debt climbed 4.2 percent over the past three months, the biggest gain among 21 developed- market indexes compiled by Bloomberg and the European Federation of Financial Analyst Societies.

Investors are buying Australian assets as they seek alternatives to the euro, dollar and yen after bailouts for Greece, Ireland and Portugal grew, while U.S. leaders have endangered the nation’s AAA credit rating.

The benchmark 10-year Australian note’s yield fell three basis points, or 0.03 percentage point, to 4.95 percent, extending its decline this month to 26 basis points. The gap to similar-maturity Treasuries widened to 197 basis points, after reaching a 14-month low of 191 on July 25.

Clothing Costs

A measure of clothing costs jumped last quarter by the most in three years from the prior three months, yesterday’s report showed. A gauge of food prices rose for a third straight quarter and transportation expenses were the most since 2008. Electricity bills have jumped almost 11 percent from a year earlier, according to the report.

A 0.6 percent decline in recreation costs was the only main category to weaken, and it reached the lowest in four years, the report showed. Education costs were unchanged from the prior quarter, it showed.

The report reflected lingering effects of floods and a cyclone that shut mines and ruined crops in the northeast. Financial and insurance expenses were up 4.2 percent from a year earlier. The cost of bananas has soared 470 percent compared with before the natural disasters.

Rate Moves

Australia, the only economy in the Group of 10 currency group to avoid a recession following the 2008 financial crisis, has the highest inflation expectations after the U.K. among eight developed markets tracked by Bloomberg.

Stevens boosted the benchmark lending rate to 4.75 percent in November, the seventh in a series of quarter-point increases, from a half-century low of 3 percent in early October 2009. The RBA aims to keep underlying inflation in a range of 2 percent to 3 percent on average. The RBA meets next week to set rate policy.

Fourteen of 15 economists surveyed yesterday by Bloomberg News predicted Stevens to keep the overnight cash rate target unchanged at the RBA’s Aug. 2 policy meeting. Kieran Davies, a Sydney-based economist at Royal Bank of Scotland Group Plc, predicts a quarter point increase then and another in November.

The gap between yields on 10-year inflation-linked bonds and debt not indexed to consumer prices widened five basis points yesterday, the most this month, to 2.82 percentage points. It stood at 2.78 percentage points today. The gap represents the average annual inflation rate anticipated by investors over the bonds’ lifetime.

Mining Boom

“We don’t see the prospect for any rate easing,” said Bill Bovingdon, chief investment officer of Altus Asset Management, at a briefing in Sydney yesterday. The CPI figure “really puts a nail in that coffin,” he said.

Finding skilled labor for reconstruction in Queensland, and flood-damaged eastern states of Victoria and New South Wales may become more difficult, adding to wage pressures.

A private report released today by Deloitte Access Economics showed the value of definite investment projects, those classed as under construction or committed to commence soon, was A$357 billion ($394 billion) last quarter, a A$70 billion increase from the value recorded in the three months through March.

The RBA signaled earlier this month that the economy is unlikely to reach its forecast of 4.25 percent growth this year because a resumption of coal exports from flooded mines is taking longer than expected. New forecasts are scheduled to be released Aug. 5.

Australia’s economy shrank 1.2 percent in the first quarter, the most since 1991, because of the natural disasters.

Treasurer Wayne Swan said underlying inflation remains “contained” and attributed almost half of last quarter’s price gains to fruit costs. Consumer prices should ease as agriculture production rebounds, he said at a press conference in Sydney. The dollar’s strength is a “mixed blessing,” he said.

To contact the reporter on this story: Michael Heath in Sydney at mheath1@bloomberg.net

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net

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