Australia's core inflation hits 16-month high, raises bets for May rate hike

By Stella Qiu

SYDNEY, Feb 25 (Reuters) - Australian consumer prices rose by more than expected in January, while core inflation hit the highest in over a year, an uncomfortable outcome for policymakers that raises the risk of another hike in interest rates.

The Australian dollar gained 0.2% to $0.7073, ?while three-year government bond futures fell 4 ticks to 95.71. ?Investors raised bets of a rate hike in May from the Reserve Bank of Australia to 80%, up from 76% before the ?data.

Data from the Australian Bureau of Statistics out on Wednesday showed its monthly consumer price ?index (CPI) rose 0.4% in January, from the previous month, driven by higher ?costs for housing, health ?and clothing. The figure topped the median forecast of 0.3%.

The annual pace stayed elevated at 3.8%.

The trimmed mean measure of core ?inflation increased by 0.3% in the month, taking the ?annual rate to a 16-month high of 3.4%, from 3.3% in December - keeping the rate above the RBA's target band of 2%-3% for the seventh straight month.

"The ?Reserve Bank's preferred trimmed mean measure was still ?too high ?for its liking," said Stephen Smith, partner at Deloitte Access Economics.

"With little chance of a rate hike in March, the next live RBA meeting will be in May, when ?the RBA will be able to take the temperature of the economy with the benefit ?of seeing the March quarter inflation figures."

The central bank was forced to raise interest rates by 25 basis points earlier this month to 3.85% after three rate cuts last year. The economy was also bumping against its speed limit as the labour market stayed tight.

The RBA had expected headline inflation ?to pick ?up to 4.2% by June this year, and the trimmed mean measure ?to rise to 3.7%.

Wednesday's report showed non-tradable inflation, mostly influenced by domestic factors, ran at 4.9% ?last month, up from 4.6%, as electricity prices jumped 32.2% and new dwellings rose 3.5%. Rent growth remained high at 3.9%.

Goods inflation picked up to 3.8% in January while services inflation slowed a little to 3.9%, from 4.1% before.

"The Reserve Bank has its work cut out to get inflation back within the target band," said Cherelle Murphy, chief economist at EY.

"We remain of the view that the central bank will need to raise ?the cash rate further, most likely in the first half of this year with further rate hikes possible given persistent inflation pressures."

RBA Governor Michele Bullock will have a chance to react to the January ?CPI when appearing at a Melbourne University ?event on Wednesday evening.

(Reporting by Stella Qiu and Wayne Cole; Editing ?by Himani Sarkar and Shri Navaratnam)