Australia's monthly inflation indicator climbed to the upper limit of the Reserve Bank of Australia's (RBA) 2%-3% target range in August, providing support for maintaining current interest rate levels while driving the Australian dollar higher.

Official data released by the Australian Bureau of Statistics on Wednesday showed the Consumer Price Index (CPI) rose 3% year-over-year in August, marking the highest level in a year and exceeding economists' prior forecast of 2.9%. However, the RBA's preferred core inflation measure, the trimmed mean, moderated from 2.7% in July to 2.6% in August. This indicator excludes food, energy and other highly volatile items, better reflecting underlying inflation trends.

The inflation data, combined with last week's employment report showing continued labor market tightness, may prompt RBA policymakers to stand pat at next week's meeting (September 29-30) while maintaining a cautious policy outlook.

Markets reacted swiftly, with the Australian dollar erasing earlier losses to gain 0.3%. Policy-sensitive three-year Australian government bond yields rose higher, and traders scaled back expectations for the next rate cut. Swap trading data linked to the RBA meeting shows an extremely high probability that the central bank will pause rate cuts at its late September meeting, while November rate cut pricing stands at 70%.

Data shows housing costs were the primary driver of rising inflation. Beyond housing costs, food and beverage prices were also significant contributors to annual inflation. Specifically, over the 12 months to August, electricity costs surged 24.6%, driven mainly by increased out-of-pocket expenses for households in Queensland, Western Australia and Tasmania. Rents rose 3.7% year-over-year, the lowest annual increase since November 2022. New dwelling prices (covering new homes and major renovation projects) increased from 0.4% in July to 0.7% year-over-year, as builders in some cities raised prices and reduced discount promotions.

Additionally, dining out and takeaway prices rose 3.3% year-over-year, the highest increase in the past year, driven by rising labor and raw material costs. Holiday travel and accommodation inflation eased as demand declined after school holidays ended in July. Insurance prices showed the smallest annual increase in over four years.

James McIntyre from Bloomberg Economics stated: "Monthly inflation surprised to the upside for the second consecutive time. While this won't derail the RBA's easing cycle, it's enough to dampen expectations for a rate cut at the September 30 meeting. This confirms our view that the pace of rate cuts will be gradual."

The RBA cut its cash rate by 25 basis points to 3.6% last month, marking its third rate reduction this year. Governor Michele Bullock said on Monday that the rate-setting committee will assess recent economic data at next week's meeting, noting that economic performance has met or slightly exceeded expectations. She pointed out that inflation has fallen significantly within the target range, while reiterating that monthly CPI indicators are highly volatile with unclear signals, expressing greater confidence in more comprehensive quarterly inflation reports.

Rodrigo Catril, a Sydney-based strategist at National Australia Bank, believes: "Overall inflation exceeded expectations, with performance in segments like housing and services remaining sources of upside risk for future inflation. Today's data provides the RBA with food for thought and may lead them to consider continuing the pause at the November meeting."

Notably, the Australian Bureau of Statistics (ABS) will begin releasing complete monthly inflation data from November 26, filling a long-standing gap in the country's economic data and aligning Australia with statistical standards of most developed nations. However, complete monthly inflation data is expected to have a transition period, meaning quarterly inflation data will remain the benchmark indicator for policy making for some time to come.