FAVOURABLE inflation figures and growing confidence the Reserve Bank will cut interest rates next week triggered the strongest day on the sharemarket this year, as investors piled into bank stocks.
The S&P/ASX200 ended the day up 1.1 per cent at 4271.3 - the highest in six weeks - after figures showed inflation was unchanged in the last three months of last year.
The data opened the way for the Reserve Bank board to cut rates when it meets next month, economists said. Many expect it to cut rates by 0.5 percentage points in the next two months.
But cuts in the official interest rate will not necessarily be passed on to mortgage customers, and that would benefit bank earnings.
The dollar ended the day above US105?, up from its previous close of US104.6? despite dipping a third of a US cent after the inflation release.
The big banks accounted for more than half of the total rise on the sharemarket, led by Westpac, which rose 3.5 per cent to $21.30, and Commonwealth Bank, up 2.4 per cent to $51. ANZ and National Australia Bank shares rose 2.2 per cent and 2 per cent respectively.
Tumbling food prices sent Australia's headline inflation rate to its lowest level since the depths of the global financial crisis. Consumer prices were unchanged in the December quarter following a 0.6 per cent rise in the third quarter of 2011, according to the Bureau of Statistics. The market had expected a 0.2 per cent increase.
The preferred inflation gauge - the average of the trimmed mean and weighted median figures - actually crept higher last month to 2.6 per cent annualised, more than the 2.4 per cent rate economists had been tipping.
St George Bank's chief economist, Besa Deda, said the moderate inflation data gave the Reserve Bank room to cut rates when it met on February 7. "The trends evident in the data will allow the door to remain open for further rate cuts," she said. "While inflation is important, top of the agenda for the RBA at the moment are global economic developments."
A drop in food prices, combined with falls in the cost of clothing and footwear and an "unusual" fall in health costs, helped keep inflation in the middle of the Reserve Bank's 2 per cent to 3 per cent target band.
The Bureau of Statistics said the large fall in fruit prices - which dropped 13.4 per cent in the quarter - was due mainly to the falling price of bananas, which fell 46 per cent in the three months to December.
Vegetable prices fell 5 per cent, audio-visual equipment dipped 3.4 per cent and motor vehicles 1.2 per cent. Pharmaceutical prices sank 5.6 per cent after more consumers exceeded the Pharmaceutical Benefits Scheme safety-net level.
The biggest price rises were felt by domestic holiday travellers, with costs up 7.3 per cent in the quarter.
Meanwhile, rents crept up 1 per cent and telecommunication equipment and services rose 1.1 per cent.
A Goldman Sachs report said the Reserve Bank was likely to cut rates by 50 basis points in the next two months because the banks would probably fail to pass on February's anticipated 0.25 per cent cut in full.
"A second rate [cut] is a 100 per cent certainty and most likely in March," it said. "This also follows last week's employment growth that was the weakest in 20 years."