Stand by for the mother of all speculative binges about whether the Reserve Bank will cut interest rates at next month's board meeting.

That's after the RBA held out the chance of a rate cut at the Melbourne Cup Day board meeting, if the September quarter consumer price index shows an improvement over the already trimmed June quarter figures.

Falling fruit and vegetable costs will be positive, but a rise in oil prices, thanks to the fall in the value of the Australian dollar, could offset that good news from the supermarket sector.

But if the domestic economy shows more strength, with building approvals and housing finance rising again for September and another solid trade performance (as seems highly likely), it is possible the bank will wait until February to see what happens.

It was only last month that Governor Glenn Mr Stevens again mentioned the outlook for inflation being a worry.

The new comments from news saw the dollar down closer to 94 USc and the market fell after regaining early losses and trading in the green for a short while.

It later regained the 95 US cent level.

And if the RBA cuts, it will be a year after the central bank lifted the cash rate to 4.25%, and found that increase almost doubled by the banks who were seeking to reclaim lending costs and repair profit margins.

In the bank's usual post board meeting statement yesterday which held the cash rate steady for the 10th monthly meeting in a row, Governor Stevens revealed a significant change in thinking.

He said, "An improved inflation outlook would increase the scope for monetary policy to provide some support to demand, should that prove necessary".

That was after what he noted was an improvement in the outlook for costs and inflation.

"Recently revised data show a pick-up to date in the underlying pace of price rises that was less sharp than initially indicated.

"Moreover, with labour market conditions now a little softer and households more concerned about the possibility of unemployment rising, the likelihood of a significant acceleration in labour costs outside the resources and related sectors is lessening.

"Taking into account all the recent information, the path for inflation may now be more consistent with the 2–3 per cent target in 2012 and 2013, abstracting from the impact of the carbon pricing scheme.

"This assessment will be reviewed on receipt of further data on prices ahead of the Board's next meeting."

The September quarter CPI and associated readings (such as the RBA's favourite measures which track underlying inflation) are due out on Wednesday, October 26.

The RBA has a bit more leeway on rates and the trade-off with cost pressures after the reworking of the June quarter CPI data before the introduction of a new CPI series in the current quarter.

The CPI will be the first of the 16th series (the 15th series ended with the June quarter's figures) and last month the ABS revealed that due to more accurate seasonal adjustment, the underlying inflation rates favoured by the RBA were less than previously reported, dropping the annual inflation rate to 2.55% from 2.7%.

"The Board noted that financial conditions have been easing somewhat, with interest rates for some housing and business loans declining slightly due to increased competition and the fall in some funding costs in financial markets," Mr Stevens said yesterday.

"The exchange rate has also declined from the very high levels of a few months ago. Credit growth remains low, however, and asset prices have declined.

"At today's meeting the Board judged the current cash rate remained appropriate. As always, the Board will continue to assess carefully the evolving outlook for growth and inflation."

But Europe remains as the spectre in the background of discussions.

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It has been a major factor behind the RBA leaving rates on hold in August and September, and yesterday it again featured heavily, with the post meeting statement stating:

"Conditions in global financial markets have continued to be very unsettled, with uncertainty increasing about both the prospects for resolution of the sovereign debt and banking problems in Europe, and the outlook for global economic growth.

"While temporary impediments that had contributed to a slowing in growth in some countries over recent months are lessening, recent data suggest a continuing period of soft economic conditions in both Europe and the United States.

"Moreover, the uncertainty and financial volatility have reduced confidence, which could result in more cautious behaviour by firms and households in major countries.

"It will take more time for evidence of any effects of the recent European and US financial turbulence on economic activity in other regions to emerge.

"Thus far, indications are that economic activity is continuing to expand in China and most of Asia.

"Nonetheless, recent events have led forecasters to reduce their estimates for global GDP growth, which is now expected to be about average this year and next.

"Prices for commodities have declined over recent weeks, though in general they remain high."

That led to the now usual comments on the resources boom (which we found confirmed again by the August trade data out yesterday).

"Australia's terms of trade are very high, which has increased national income considerably.

"Investment in the resources sector is picking up very strongly and some related service sectors are enjoying better than average conditions.

"In other sectors, cautious behaviour by households and the earlier rise in the exchange rate have had a noticeable dampening effect.

"The impetus from earlier Australian Government spending programs is now also abating, as had been intended.

"While there remain good reasons to expect solid growth over the medium term, the indications are that the pace of near-term growth is unlikely to be as strong as earlier expected, due both to local and global factors, including the financial turmoil and related effects on business confidence, " Mr Stevens said.

And with the bank thinking inflation is not going to be as bad as previously estimated, a rate cut becomes possible.

Last month we reported on the changes to the new CPI.

The new 16th series of the CPI will be released with the September quarter report on October 26. It replaces the 15th series which ended with the June quarter report, released in late July.

The revisions to the important core inflation readings watched closely by the Reserve Bank were done in a comparison of the readings in the 15th and the new 16th series of the CPI.

As a result, the second quarter core inflation reading dropped to 0.6% (Series 16), from 0.9% (15th series) reported in late July when the June quarter CPI was released.

The core inflation CPI is the one the RBA looks at to get a bearing on inflation.

It consists of two parts: the trimmed mean which was cut from July's 0.9% (16th) to 0.7% (15th) and the weighted median which fell to 0.5% (16th) from 0.9% (15th).

The annual inflation rates under these measures fell to 2.5% for the trimmed mean (2.7% under series 15) and 2.6% (2.7% under series 15) for the weighted median.

That gives the RBA a bit more room to cut, if it sees the need.

Copyright Australasian Investment Review.

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