* Q3 CPI under forecasts at +0.5 pct q/q, 1.7 pct y/y
* Core inflation measures surprisingly low at +0.3 pct
* Market narrows odds on rate cut, slaps down A$
By Wayne Cole
SYDNEY, Oct 28 (Reuters) - Australian inflation was surprisingly subdued last quarter with few signs of price pressures right across the economy, an open invitation to further cuts in interest rates that sent the local dollar sharply lower.
The Australian currency shed three quarters of a U.S. cent as key measures of underlying inflation rose by just 0.3 percent in the third quarter, the smallest increase since 2011 and below market forecasts of 0.5 percent.
The annual pace of core inflation slowed to around 2.15 percent, from 2.3 percent in the second quarter.
That was less than what the Reserve Bank of Australia (RBA) had been projecting and almost at the floor of its long-run target band of 2 percent to 3 percent.
Investors immediately reacted by ramping up wagers on a cut in rates at the central bank's Nov. 3 policy meeting.
"The fact that the core is so weak is material because that tends to be what the RBA targets," said JPMorgan (N:JPM) senior economist Ben Jarman. "This has definitely got the hares running on the prospect of a near-term RBA cut."
Interbank futures jumped to imply a 50-50 chance of an easing in the 2 percent cash rate next week, up from one-in-five before the data. December implied an 82 percent probability and a move to 1.75 percent was fully factored in by February.
Australia is grappling with the end of a long mining boom, but the central bank has had to tread carefully in order to avoid further fuelling a hot housing market.
Talk of an easing had already been stoked by the recent decision of Australia's major banks to lift mortgage rates in an effort to shield profits from rising regulatory costs.
"You have to say data like this coupled with what the banks have done recently with the tightening up in conditions must increase the risk of a move before year end," said Su-Lin Ong, a senior economist at RBC Capital Markets.
"November may still be a bit early but you can't rule it out and the risk is a lot higher for December."
Wednesday's data from the Australian Bureau of Statistics also showed its headline consumer price index (CPI) rose 0.5 percent in the third quarter, a slowdown from the second quarter when it rose 0.7 percent.
The annual pace of CPI inflation held steady at 1.5 percent and below market forecasts of 1.7 percent.