SCOREBOARD: Dip doubts

Honestly, I was very nervous about the ISM. The way things had been working a modest 0.7 per cent dip in the ISM (to 55.5, 54.5 expected) would have incorrectly been used as proof the US was slowing – well, double dipping. As it is, risk came on in size. I suspect the change in market response stems from the growing realisation that even when these indices dip, as long as they remain above 50, they're still showing the economy expanded – that the economy was stronger over the month. Now this is particularly good news following the remarkable expansion in US private demand that we saw in the GDP numbers. As I've already mentioned, strong import growth does not indicate a slowing economy and no matter what measure of growth you want to look at, if you abstract from the surge in imports (and inventories if you want), then it was strong.

So, throw in a virtually unchanged UK PMI (57.3 from 57.5), a modest lift in the EC PMI (56.7 from 56.5) and another sold run of earnings and equities surged higher. In Europe the major indices were about 2.3 to 2.7 per cent higher, lead by banks and resource stocks. Across the Atlantic then, the bid was applied straight from the open and stayed on throughout the whole session. The major indices closed just off their highs, with the S&P rising 2.2 per cent to 1125, the Dow 208 points to 10674 and the Nasdaq 1.8 per cent (2295). As in Europe, financials and resource stocks were the key outperformers - crude up 3.2 to $81 (highest since early May), copper up 2.4 per cent and gold up smalls (to $1182) – while consumer stocks and healthcare lagged (still with solid gains of between 1.5 and 2 per cent). Despite the bank/resource led spike overnight, SPI looks to have underperformed rising only 1.4 per cent in the session (4570).

With risk appetite expanding, USD was hit, falling over a big figure against euro (1.3172, and highest since early May) and sterling (1.5889, highest since February). AUD put on another 40 pips to 0.9130 while Yen was barely changed at 86.43.

As for rates, well moves were comparatively subdued with light volumes and narrow trading ranges (2-6 bps). At the close the 2-year yield was up 1 bps to 0.56 per cent, the 5-year up 3 bps to 1.64 per cent and the 10- year 4 bps to 2.96 per cent.

This swing in sentiment should serve as a warning against complacency over the domestic rate outlook. Fair to say that a rate hike today (1430) is unlikely. Following last week's CPI it became obvious that there is no rush, particularly with credit growth as sluggish as it is. In an ideal world then, CPI will continue to head lower over coming quarters allowing the RBA to remain on hold for the rest of the year and well into next. Unfortunately I don't think this is going to happen.

It's very obvious that most of the factors leading to the weaker-than-expected inflation outcome in Q2, did not represent persistent underlying forces – food, energy, insurance, urban transport fares, travel. Ultimately when you think about inflation this is what you should be concerned about - the persistent trends, abstracting from one-offs or anomalous outcomes. When you do that, then the RBA's core measures probably misrepresent core inflation – true core inflation (being the persistent trend) which I put at 0.7 per cent for the quarter just gone, rather than the RBA's estimate of 0.5 per cent.

Unfortunately it was more luck than any skill in forecasting that saw the RBA's core estimate drop to their forecast rate. If I'm right, then we should see core inflation bounce higher again in Q3, in which case the RBA could well hike again in November. As for the statement, I'm not expecting any magic or major change of direction and of course we get the quarterly Statement on Monetary Policy on Friday anyway.

Prior to the RBA's decision we get June building approvals (market and me at 2 per cent) and retail sales at 1130 (market at 0.4 per cent; me at 0.6 per cent). Tonight, watch out for personal spending in the US, factory orders, pending home sales and vehicle sales. Elsewhere we get euro zone PPI.

Adam Carr is senior economist at ICAP Australia. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.