International uncertainties and domestic risks suggest a need to cut by 25 basis points

Virtually everyone who follows these matters expects the Reserve Bank to cut interest rates today, with some predicting (or calling for) a cut of 50 basis points.

Inflation is low, non-mining activity is weak and the government has promised a substantial fiscal tightening.

Internationally, the China boom is slowing, the US recovery may be fading and the eurozone is in recession with the continued possibility of a disorderly break-up of the single currency union.

A cut of either 25 of 50 basis points would be acceptable, but this writer leans to the lesser cut for reasons to be explained.

The key aspect of the domestic economy is that a massive investment boom is under way.

Mostly this is private investment in great mining projects, but government-funded infrastructure spending is also crucial if Australia is to take maximum advantage of the mining boom.

Sadly, the need to restore fiscal stability and advertise clearly that actions to achieve this are being followed, seems likely to impose on us all a sharp fiscal tightening.

This would have been avoided if more restraint had been maintained during the crisis and especially if stimulus had consisted of spending or other reforms to raise productivity instead of wasteful "Keynesian" stimulus, almost on a par with digging holes and filling them in again.

Achieving even a modest surplus when tax receipts are low and the budget deficit is still expanding will involve cutting spending in a number of areas, including highly desirable spending on infrastructure, defence and welfare.

There will also, it seems, be an extension of means tests and other actual or covert tax hikes, the net effect of which will be to reduce incentives to work hard and to innovate.

The RBA's clear mandate is to keep goods and services inflation under control while maintaining overall financial stability.

The very low "headline" inflation for the March quarter included some one-off price falls, including fruit and vegetables.

But this aside, low global inflation and a rising Australian dollar meant so-called tradeable goods inflation was especially low, in a number of cases negative.

Low or negative inflation was sufficient to mask a noticeable increase in "non-tradeable" goods.

"Non-tradeables" inflation (home-made inflation) rose by 1 per cent in the quarter, or 3.6 per cent over the year.

Areas that experienced price rises were education, up by 6 per cent in the quarter (with a 7.7 per cent rise in secondary-school prices); recreational, sporting and cultural services 2 per cent; veterinary and pet services 1.1 per cent; health 4.4 per cent (due to Pharmaceutical Benefits changes); utilities 2.1 per cent (including electricity up by 3 per cent); rents 1 per cent; petrol 2.5 per cent; and urban transport fares 4.6 per cent.

Home-made inflation was sufficient in the March quarter to keep average prices rising despite the welcome traded goods deflation, reinforced by a rising dollar, which, of course, is falling already, and this may increase with a rate cut today and if the promised budget deficit is credible.

The big swing factor is the investment boom already under way, but this is predicated on continued strong commodity prices, and one assumes falls seen already in commodity prices are properly factored into the mining companies' plans.

Chinese economic growth has slowed to a mere 8 per cent annual rate and there is general belief that China's growth is unlikely to dip further, but I am less certain than most about this matter.

China's inflation reached a recent peak of more than 5 per cent, then fell and most recently has revived somewhat.

China's leaders may feel cheaper commodities would be a suitable reward from a more subdued economy and if that is the case, the froth will come off Australia's mining boom.

For some months the US recovery seemed to be stronger than expected and corporate results surprised on the upside, yet the latest jobs figures suggest at least a stumble in recovery and the US Federal Reserve has warned of a slow recovery.

The global benefit of this is that US interest rates should be lower for longer.

US Fed chairman Ben Bernanke has reiterated his position that US cash rates are likely to remain at about zero until late 2014.

A zero cash rate in the US is simply unsustainable.

Meanwhile, the eurozone crisis stumbles on.

Germany is trying to force all eurozone countries to embrace German work habits and industrial success, while benefiting from a low euro, precisely because of the reluctance of the Club Med nations to come in from the beach and start working like joyless Germans.

The Dutch government failed to implement a Germanic austerity plan and was forced to resign, France is busy electing a socialist president.

Meanwhile, Spain is struggling to meet its debt repayments and its bond yields hit the recognised danger point of 6 per cent, and Greece and other weaker nations have defaulted or soon will, entering into schemes of arrangement to pay only small proportions of debts, like land-booming tycoons after the bubble burst in Marvellous Melbourne in the 1890s.

The overall global view is little changed, but the potential for fresh drama is clearly present.

The RBA has probably no choice but to cut rates and in doing so accept some criticism for having misread the economy.

Such criticism is unfair, but even the flinty eyed Glenn Stevens will feel he has to give some ground to his critics.

But it would be wise to keep some powder dry in case the international situation deteriorates markedly.

Conversely, maintaining a firm grip on the economy provides some insurance against the possibility that a demoralised labour movement decides to grab what it can before the change of government that looks increasingly certain.

Both the international uncertainties and the domestic risks suggest the need to cut by 25 basis points rather than 50 at this time.

The general outlook is for a long period of slow growth as nations, firms and households reduce leverage, cut debts, save more and consume less.

Ideally, as well as fighting fires, political and official leaders would be rethinking ways in which growth became unsustainable in the past 30 years and how to encourage more sensible, less resource-intensive growth.

Sadly, there is little sign this is happening, and the prevailing ethos seems to be restoring the Club Med culture as quickly and as thoroughly as possible.

Nations that maintain a firm monetary policy and restore a sound fiscal policy will do better in this time of relative austerity.