The Australian dollar slumped over a cent and bond futures rallied on Wednesday after surprisingly tame inflation data led investors to doubt the central bank would raise interest rates next week.

Within seconds of the inflation report, swap rates dropped and the Australian dollar fell as far as $0.9720, from New York's $0.9844. Support was seen at $0.9665.

Stop-loss selling under $0.9818 and $0.9750 had aggravated losses, with a rebound in the U.S. dollar further squeezing the currency.

"The RBA decision next week will be a close call, especially with the consumer price index data today not providing the so-called 'smoking gun,'" said Helen Kevans, a JPMorgan analyst.

Data showed a measure of underlying inflation favoured by the Reserve Bank of Australia (RBA) had cooled to an annual rate of 2.5 percent in the third quarter, the slowest pace in five years and under forecasts for a 2.6 percent gain. [ID:nSGE69P0M8]

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Yet, many analysts noted even if the RBA does not lift rates to 4.75 percent at its Nov 2 meeting, from 4.5 percent now, it was merely postponing the inevitable. That should prevent the Aussie dollar from falling too far.

After all, the RBA itself has said many times rates must go up to prevent booming commodity exports from fuelling inflation.

Indeed, Stephen Walters, an economist at Nomura, said while third-quarter inflation was within the RBA's target 2-3 percent range, inflation is unlikely to ease further from here.

"We still judge the RBA likely to hike its cash rate at the November policy meeting as it needs to be pre-emptive in dealing with the issues of above-trend growth that it expects over 2011-12," said Walters, one of the few who correctly predicted the RBA would not hike in October.

Investors were badly burnt in October after the RBA left rates unchanged at 4.5 percent, contrary to widespread expectations for a hike.

By late trade, the market was priced for just a 17 percent chance of a hike next week, down sharply from 60 percent seen earlier in the day. November interbank futures <0#YIB:> jumped 0.07 points at 95.46.

The spread between 10- and three-year yields widened to 25 basis points, up sharply from just 7 basis points seen in early October, and leaving the curve at its steepest in over a month.

Bond futures investors were trading for a steeper curve too. Three-year bond futures jumped 0.08 points to 95.08, while 10-year futures lost 0.02 points to 94.785.

The slump in the Aussie dollar helped the New Zealand dollar outperform its neighbour. The Aussie dollar hit a one-week low of NZ$1.3009 , from NZ$1.3056 before the inflation data.

Against the greenback, the kiwi was steady around $0.7478, after ranging between $0.7465/$0.7501, with an improvement in business confidence for the first rise in five months failing to excite markets. [ID:nSGE69Q03P]

The tentative improvement was not seen as having any impact on the central bank's rate policy in the near term, after a run of very weak data.

"Today's data suggest that the stilted recovery should continue into 2011, with a policy normalisation process to match," said RBC Capital Markets strategist Michael Turner. "We continue to expect a resumption of this process in March 2011."

The central bank reviews its benchmark rate on Thursday, but analysts see virtually no chance of a rate rise, with the bank seen on hold well into 2011 because of stuttering economy. [NZ/POLL]

Markets are pricing in around 64 basis points of tightening over the next 12 months, up from 52 basis points earlier this week, but it was down from 72 basis points mid last month.

NZ debt <0#NZTSY=> was firmer, after initial softness, with yields edging lower.