By Stella Qiu

SYDNEY (Reuters) - Australian consumer price inflation slowed to a three-year low in August thanks to government rebates on electricity and a drop in petrol, while core inflation hit its lowest level since early 2022 in a sign costs were cooling.

Market reaction was restrained as the central bank had already said it would look through the decline in headline inflation, which is not enough to justify rate cuts in the near-term.

The Australian dollar came off its 1-1/2-year high and was last flat at $0.6890, while three-year bond futures were little changed at 96.64.

Swaps imply a 75% chance that the Reserve Bank of Australia can start lowering rates in December after it held policy steady and did not discuss the option to hike on Tuesday.

Data from the Australian Bureau of Statistics on Wednesday showed its monthly consumer price index (CPI) rose at an annual pace of 2.7% in August, down from 3.5% in July and dead in line with market forecasts.

On a monthly basis, the CPI fell 0.2% in August from July.

Electricity prices fell almost 15% in August, while petrol dropped 3.1%. On an annual basis, electricity prices tumbled 17.9%, the biggest annual fall since the early 1980s.

That is thanks to electricity subsidies from the federal and state governments, noted the ABS. Otherwise, they would have risen 0.1% in August.

The RBA has kept rates steady since November, judging that the cash rate of 4.35% - up from a record-low 0.1% during the pandemic - is restrictive enough to bring inflation to its target band of 2-3% while preserving employment gains.

However, underlying inflation - which ran at 3.9% last quarter - has fallen very little over the past year, a reason that policymakers are not confident that inflation is moving towards the target range.

Indeed, a closely watched measure of core inflation, the trimmed mean, slowed to an annual 3.4%, from 3.8%, leaving it above the 2-3% target band and a hurdle to cuts in interest rates.

The monthly report also provided the first update on many services for the quarter, which showed services inflation stood at 4.2% in August from a year ago, only slowing a little from July's 4.4%.

"Trimmed mean also came in lower, but not to the same extent as headline, which suggests a dominant fuel component to the headline rate," said Dwyfor Evans, Head of APAC Macro Strategy at State Street (NYSE:STT) Global Markets.

"The RBA remains wary of inflation trends for now, so monetary policy will look through this one month of abnormal price data."