Europe's deal gives RBA good reason to sit tight

The Reserve Bank board said after its meeting last month that the arguments had been finely balanced.

"Recent domestic data generally had not suggested a significant weakening in conditions compared with the forecasts a month earlier," it said. Inflation was low and was expected to remain near the bottom of the target zone.

And, in any case, there had not been time to assess the effects of earlier cash-rate reductions.

The big worry was "clear evidence suggesting a softening in global conditions", and increased uncertainty about the future in Europe, with the possibility of increased "precautionary behaviour" here.

Now Europe has reached some sensible compromises, providing hope there will be more in due course.

The domestic situation has not weakened, employment has been strong and, indeed, increased export volumes have offset weaker commodity prices.

If ever there is an iron-clad case for the RBA to sit tight, with monetary policy on the easy side of neutral, today presents such a case.

Events in the eurozone have been dramatic, with plenty of good judges suggesting disaster was a real possibility.

Germany and a few other northern nations are growing and seem on top of their economic challenges, but the Club Med nations are in deep recession with unsustainable national debt mountains, in most cases piled on top of equally damaging Everests of private debt.

Five such nations have asked for help to rescue their banks, and others may join that queue soon.

Germany, which will eventually be forced to lead the rescue of the weak nations, or abandon them, faces great dilemmas.

Germany's instinct is not to bail out weak nations and weak banks, including its own, without imposing strict conditions that will include budgetary austerity and microeconomic reform.

Weak governments will have to agree to impose such conditions, putting their own tenures at risk, with dangers of growing economic and social unrest and possibly provoking the rise of darker nationalistic forces.

Although austerity and economic reform come straight from the economist's playbook, there are two ingredients missing.

The first is currency devaluation.

Australia's substantial currency depreciation in the early 1930s is judged by historians to have helped produce its relatively fast recovery from depression. And the 10 per cent wage cut contributed to boosting national competitiveness.

A second ingredient for recovery is hope for the future.

Unrelieved austerity, especially when a country's unemployment rate is high (24 per cent in Spain, 50 per cent among the youth) and rising, gives no hope.

Being told to work harder and smarter, when there is no work, makes a mockery of leadership.

Australia in the Great Depression had plenty of austerity, but also a coherent recovery plan (including some new public works) devised by our economists and imposed by our government.

When the man from the Bank of England attempted to impose unrelieved austerity, he was widely condemned, and lampooned in popular verse and radical songs: Otto, the rotter, Neimeyer.

The agreement reached on Friday finally made some concessions to the case put by the Club Med members of the eurozone, and saw Germany finally stop saying "nein" to every such suggestion.

Psychologically, the compromises finally deliver hope to those people from warmer nations.

They include several contributions to hope for the unemployed.

A E10 billion ($12.3bn) boost of capital for the European Investment Bank, expected to raise overall lending capacity by E60bn.

Targeting E60bn of unused structural funds to help small enterprises and create youth employment.

A pilot launch of EU project bonds worth E4.5bn for infrastructure improvements, focusing on energy, transport and broadband.

Crucially, the eurozone leaders have agreed to use the eurozone's planned bailout fund to directly support struggling banks, without adding to government debt.

After many hours of talks, they also agreed to set up a joint banking supervisory body for the eurozone.

There is now the prospect that in the longer term there may be a eurozone-wide fiscal authority with teeth and euro bonds, relegating national bonds to the status of state bonds in thoroughly federated nations.

I remain doubtful that cultural differences will ever allow a fully functioning eurozone federation, or indeed that such a solution is desirable, even on narrowly economic terms. But I am relieved that the eurozone leaders have finally shown the ability to reach the sort of sensible compromises required in any democratic nation, because this removes the possibility of deadlock leading to unpredictable economic meltdown.

Time has been brought, and the RBA is entitled to sit and watch how the current, more hopeful, situation plays out.

The general point is that the eurozone crisis has a long way to go yet, and China and the US are growing more slowly than we are used to seeing.

Perhaps this is the new condition for us all, and it would not be all bad if it was.