Headline consumer prices probably advanced 3.8 per cent in the second quarter from a year earlier, from 3.6 per cent in the prior period, economists predicted ahead of Wednesday’s release. Trimmed mean inflation, which smooths out volatile prices and is a key core measure, is seen holding at 4 per cent. That is above the Reserve Bank’s latest forecast of 3.8 per cent and suggests limited progress in reining in prices.

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“If inflation is four-point something and they don’t raise, it starts to substantially bite into their inflation-fighting credibility,” said Stephen Miller, an investment strategist at GSFM. “What that might mean is the longer tenor bond yields in Australia struggle and certainly underperform the US.”

The Reserve Bank has raised rates by less than global counterparts as it sought to hold on to employment gains while being worried about the capacity of heavily indebted households to cope. Stubborn inflation that suggests the RBA would fail to meet its goal of returning price gains to the 2 to 3 per cent target late next year is likely to require a further hike — and risks tipping a weak economy into recession.

The price report comes on the heels of higher-than-forecast jobs growth and strong retail sales, while measures of business surveys remain resilient. A partial gauge of prices rose by more than expected for a third straight month in May, raising questions over whether policy is “sufficiently restrictive.”

The RBA has pledged to be “vigilant” on upside price risks and the rate-setting board considered a hike in June, before deciding to stand pat at 4.35 per cent. Although the odds are lower from earlier this month, money markets are still pricing a one-in-five chance that the Reserve Bank will raise the rate at the August 5-6 meeting.

“Inflation in Australia is still high relative to its global peers,” said Diana Mousina, deputy chief economist at AMP. She reckons a quarterly result above 1 per cent “would probably lead to the Reserve Bank hiking” as it would be farther away from its inflation goal.

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On Friday, every major group in the US S&P 500 rose on bets that a Fed easing cycle will keep fuelling corporate America — with the bull market broadening beyond a narrow group of companies. While big tech has enjoyed massive gains this year, the so-called concentration risk has come to the forefront after a disappointing start of the megacap earnings season.

The rotation into economically sensitive shares has been fuelled by Fed-friendly data. Investors who for months saw fewer alternatives to a tight group of market winners were suddenly faced with more choices. Financial, industrial and staples shares have largely beaten tech in July. Small caps have rallied 10 per cent on bets they’d do better amid lower rates given their higher debt loads.

“We’ve seen this strength in small caps — a significant rotation not seen in decades,” said George Maris at Principal Asset Management. “As we see earnings likely broaden out and recover, you’re going to see greater enthusiasm for those smaller cap names. There is going to be lasting power to this rotation.”

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