Two rate cuts look odds-on

FAVOURABLE inflation figures and growing confidence that the Reserve Bank will cut interest rates have sparked a rise in the sharemarket, with investors piling into bank stocks.

The S&P/ASX 200 Index ended the day up 47 points, or 1.1 per cent, to 4271.3 - the highest in six weeks - after figures showed inflation was unchanged over the last three months of 2011.

Market economists said the data cleared the way for the Reserve Bank to cut rates when it met next week.

Many now expect the central bank to cut rates by 0.5 percentage points over the next two months.

But cuts in the official interest rate will not necessarily be passed on to home lending customers, and that would benefit bank earnings.

The dollar ended the day above $US1.05, compared with its previous close of $US1.0497 despite dipping a third of a US cent immediately after the release of the inflation figure.

The big four banks accounted for 53 per cent of the rise in the sharemarket benchmark.

Westpac led the way, climbing 3.5 per cent to $21.30. Commonwealth Bank gained 2.4 per cent to $51, ANZ rose 2.2 per cent and National Australia Bank was up 2 per cent.

Market economists said the Reserve Bank was likely to cut rates next month.

Tumbling food prices sent the headline inflation rate to its lowest 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 September quarter, according to the Australian Bureau of Statistics. The market expected a 0.2 per cent increase. The Reserve Bank's preferred gauge actually crept higher last month to 2.6 per cent annualised, more than the 2.4 per cent rate economists had tipped.

St George Bank chief economist Besa Deda said the moderate inflation data gave the Reserve room to cut rates at its February 7 meeting.

''The inflation trends evident in the data will allow the door to remain open for further rate cuts from the RBA,'' she said.

''While inflation is important, top of the agenda for the RBA at the moment are global economic developments, especially European ones.''

The big drop in food prices, combined with falls in the cost of clothing and footwear and a fall in health costs, helped keep inflation in the middle of the Reserve's 2-3 per cent target band.

The Bureau of Statistics said large falls in fruit prices - which dropped 13.4 per cent in the quarter - were due mainly to the plummeting price of bananas, which fell 46 per cent in the December quarter as supply increased, following the devastation caused by cyclone Yasi last February.

Pharmaceutical prices sank 5.6 per cent after a larger proportion of consumers exceeded the Pharmaceutical Benefits Scheme safety net than in the September quarter.

Vegetable prices fell 5 per cent, audio-visual equipment dipped 3.4 per cent, and motor vehicles slipped 1.2 per cent.

The biggest price rises were felt by domestic holiday travellers. Costs were up 7.3 per cent. On the other hand, rents crept up 1 per cent and telecommunication equipment rose 1.1 per cent.

A Goldman Sachs report said the Reserve Bank was likely to cut rates by 50 basis points over the next two months.

This was because the big banks would probably fail to pass on in full next month's expected 25-basis-point cut.

''A second rate cut is a 100 per cent certainty and most likely in March,'' the report said. ''This also follows last week's employment growth that was the weakest in 20 years.''