Australia's consumer prices unexpectedly fell for the first time in almost eight years in the fourth quarter, driving down the nation's bond yields and currency as investors bet the central bank won't raise interest rates.

The consumer price index dropped 0.1 percent after gaining 0.9 percent in the third quarter, for an annual rate of 3.3 percent, the Bureau of Statistics said in Sydney today. The median estimate of 26 economists surveyed by Bloomberg News was for a 0.2 percent quarterly gain and a 3.6 percent annual rate.

The Reserve Bank of Australia's three interest-rate increases last year have cooled the economy and stalled inflation, damping expectations Governor Glenn Stevens would raise borrowing costs again this year. The currency is heading for its biggest one-day decline in seven months after today's report.

``This makes our forecast for a February interest-rate increase unlikely,'' said Anthony Thompson, senior economist at Westpac Banking Corp. in Sydney. ``The Reserve Bank can look at this number and argue that the upward drift in core inflation has passed.''

The Australian dollar dropped to 78.37 U.S. cents at 3:47 p.m. in Sydney from 79.22 cents immediately before the bureau's report. The yield on the benchmark 10-year government bond fell 11 basis points to 5.83 percent and is heading for its biggest one-day drop since November. A basis point is 0.01 percentage point.

Core Inflation

No economist of 25 surveyed by Bloomberg News today expects an interest-rate increase in February, down from six predicting an increase in a survey earlier this month. Sixteen of 24 say interest rates won't change in 2007, with five predicting an increase and three a decrease by the year's end.

A Reserve Bank's measure of so-called ``core'' inflation, the trimmed mean, rose 0.5 percent from the third quarter and 2.9 percent from a year earlier, the bank said today in Sydney in a separate report. Economists estimated a 0.7 percent quarterly rate and 3.1 percent annual gain.

The Reserve Bank targets an annual inflation rate of between 2 percent and 3 percent. It raised its benchmark interest rate by a quarter percentage point in May, August and November, taking the overnight cash rate target to a six-year high of 6.25 percent.

Tempering inflation, gasoline costs fell 12.4 percent, today's report showed, and fruit prices dropped 5.2 percent. Medicines declined 5 percent.

Falling gasoline prices may lead to a headline annual inflation rate ``with a two in front of the decimal place relatively soon,'' Anthony Richards, the Reserve Bank's head of economic analysis, said in a speech last November.

Political Boost

``Assuming world oil prices remain around current levels, we cannot rule out the possibility that the headline rate might even have a one in front of the decimal place by around mid-2007.''

The report and its effect on interest rates may boost the political fortunes of Australia's 11-year-old government as it trails in opinion polls ahead of an election due in the second half of 2007.

The opposition Labor Party leads the governing coalition of the Liberal and National parties by 55 percent to 45 percent, according to a Newspoll on Jan. 23.

``This is a confidence booster. It shows what appeared to be a spike in Australian inflation rate seems to have disappeared,'' Prime Minister John Howard told reporters in Canberra after the report was released.

``There's no doubt if you were looking at the relationship'' between inflation and moves in interest rates, ``it's good news on that front.''

Consumer Spending

Australia had one of the fastest annual inflation rates in the 30-member Organization for Economic Cooperation and Development at the end of last year.

The U.S. annual inflation rate was 2.5 percent in December from a year earlier, and the U.K.'s was 3 percent. Inflation in the 12 nations sharing the euro currency in December was 1.9 percent. In contrast to Australia, the annual rate is accelerating in these three economies.

Rising interest rates are cooling household spending and borrowing, putting a brake on inflation. Retail sales climbed at the slowest pace in six months in November and home-loan approvals dropped for a fourth month, the government reported this month.

Australia's economy grew 0.3 percent in the third quarter from the previous three months, the slowest pace in more than three years, as a drought cut farm output and companies reduced stockpiles and investment.

The Bureau of Statistics' measure of core inflation, which excludes volatile items such as gasoline, fruit and vegetables, rose 0.7 percent in the quarter for an annual increase of 2.3 percent.

The Reserve Bank prefers its own ``trimmed median'' measure of underlying inflation to the bureau's ``core'' measure, Richards said in his speech.

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By Hans van Leeuwen

To contact the reporter on this story: Hans van Leeuwen in Sydney at hvanleeuwen1@bloomberg.net .

©2007 BLOOMBERG L.P. ALL RIGHTS RESERVED.