Thanks to the strong dollar and shy consumers, plus the growing price war between Coles and Woolies, Australian inflation surprised on the downside in the December quarter.

Again, the chorus of Cassandras in the markets and their “Rate Rise Looms” backing groups among the business and economic writers in the media were very much wrong.

The headline rate for the CPI showed a 0.4% rise in the quarter, down from the 0.7% in the September quarter and well under the confident expectations from market economists for a 0.7% risen (and higher from a couple of forecasters).

That was despite the expected sharp jump in fruit (up 15.5%) and vegetables (up 11.1%) in the quarter, an increase that is likely to be repeated to some extent this quarter because of the floods. They drove food prices up by 2.2% in the quarter, which was the biggest rise among all the groups in the CPI survey.

The annual rate was 2.7% down on the 2.8% (restated) for the year to September.

More importantly, the underlying rate used by the Reserve Bank showed either no change, or eased a touch. A combination of the trimmed mean and weighted median, the two measures used by the RBA showed a rise of 0.4% in the last quarter, the same as the headline rate (and down from the September quarter’s 0.55%), for an annual rise of 2.25%, down on the 2.45% in the year to September.

The ABS said:

“The most significant price rises this quarter were for fruit (+15.5%), vegetables (+11.4%), domestic holiday travel and accommodation (+3.8%) and automotive fuel (+2.1%).

“The most significant offsetting price falls were in pharmaceuticals (–6.2%), deposit and loan facilities (–1.3%), motor vehicles (–1.0%), audio, visual and computing equipment (–4.8%) and motor vehicle repair (–1.9%) and clothing and footwear, which fell 1.9%.”

This doesn’t necessarily rule out an interest rate rise from the RBA in the coming months, but it makes one unlikely, even if the labour force figures remain strong. We will get the RBA’s view of 2011 twice next week; the post-meeting statement on Tuesday from governor Glenn Stevens and then the first of the usual four statements on monetary policy on Friday.

Tuesday’s board meeting will have the latest RBA forecasts on growth and inflation that will be published on Friday  (and could be mentioned in Tuesday’s statement).

What the CPI does confirm is that the higher value of the Australian currency, the price war that Coles has started against Woolworths, which is now replying, and the “new frugalism” among consumers, are combining to exert downward pressure on cost pressures greater than many people imagined.

The Producer Price figures on Monday showed no real change in the December quarter (up 0.1% at the final stage), as the impact of the higher dollar cut the cost of imported materials and goods.

Retailers selling computers and consumer electronics goods, cars, clothing and footwear and other imported items, are doing it tough and not even price cuts and other promotions can get consumers to spend more. The internet is not the concern, it’s the intense price deflation being generated by the dollar, combined with the reluctance of consumers to lash out and spend, spend, spend.

There were one-offs, or unusuals in this report, the fall in drug prices was a result of the budget decision and usually happens at this time, but then the sharp rise in tobacco prices in the June and September quarters of last year were a result of government policy. Leaving those out, the CPI and underlying inflation remains closer to 2% than 3%, despite what the doomsayers and gloomier economists and their media mouthpieces might think.

The problem will come later in the year when the impact of the rebuilding of Brisbane and other flood-impacted areas runs into the expanding resources boom.