RBA should lift interest rates but it won't

Late last week, new information suggested that China's manufacturing purchasing managers' index rose for the first time in four months. The latest GDP data shows a modest slowing in annual growth from almost 12 per cent to just over 10 per cent in the year to June. Sizeable wage increases partly reflect catch-up from a period of firm control, but is also consistent with a planned shift to more robust domestic growth.

So far, retail sales and export growth remain strong. India's growth has also been strong, with perhaps a greater inflationary threat than apparently now in China.

Southeast Asia's strong post-crisis growth has moderated somewhat, but it still runs at rates that bode well for Australian exporters.

Overall, the three global problem areas that have been causing legitimate concern to the RBA seem to have reached the point where the assumption of "continued progress" in global recovery is a more likely best guess than disruption.

This makes the state of the Australian economy the main issue that should concern the RBA board. Domestically, the two big items of news have been the closeness of the recent federal election and the dramatic improvement in Australia's Current Account Deficit (CAD).

The robust state of Australia's financial markets during the political crisis must mean that business expects either major party, with whatever minority support either side can muster, will deliver safe and reasonably effective government.

Hardheads, of course, have bemoaned the fact that there are no bold reform plans on the table. While this has been the case so far, in a situation of effective political dead-heat leaders or leadership groups may be tempted to offer some serious reform options.

This writer's money would be on serious tax reform, and if either party had the ability to exclude the "elegant algebraic constructions" from Ken Henry's review, it would have a useful working blueprint to consider. As far as the short-term state of the economy is concerned, the main point is that there are signs of strength across the board - consumers are spending (if disproportionately not in the monopoly retail establishments), business investment is booming and set to strengthen further, exports are setting new records and jobs growth remains strong.

Most importantly, Australia's terms of trade look like being stronger for longer than mainstream forecasts have it, and this will put great strains on the fabric of Australia's economy and society.

Australia will need several more rate hikes to avoid excess economic activity causing troubling inflation.

There is no good reason why the RBA should not get on with its program of small tightening steps. If it does not do so now, it will be playing catch-up later.

Catch-up is, of course, the traditional game for Australia's central bank, but perhaps it can do better now.