RBA plays a dangerous game

Headline inflation remains in the target range at 2.3 per cent. The latest numbers on credit growth have declined further, although they are still too high for total comfort. The general view is that house prices are declining but not precipitately - although the available statistics are totally inadequate. Recent retail sales numbers have been subdued, but employment is rising.

All this must be creating a palpable sense of relief among Australia’s central bankers. The election after all was fought on the premise that interest rates would be lower under the incumbent government than its opposition. The governor remained silent about the correctness of that proposition and clearly has no appetite for conducting the by-now long-overdue defence of central bank independence in public. With the latest economic numbers giving some comfort that the “miracle economy” is not clearly out of control, he will not feel duty bound to raise interest rates immediately.

A really independent central banker - for example one born and bred in New Zealand - would have raised interest rates during the election campaign when the “interest rates will always be lower” theme was running so strongly.

However, despite relief about the case for further immediate inaction, the board will no doubt review the international and domestic economic indicators. It will find its worst fears about the world economy have been unfounded. The US is still growing, and Mr Greenspan has started his tightening cycle with considerable resolution. China has not crash-landed and Japan is firming. Monetary policy has been slightly tightened in Taiwan, Singapore and China. Euroland is adrift as usual, but hopefully is not slipping back into recession.

A quick run around the domestic economy shows clearly what ought to be done. Expenditure and incomes are thriving. However, domestic inflation is too high. Asset inflation is still entrenched. Exports are stagnant, and indeed have been for three years now. Imports are still rising. The big - and bigger - current account deficit is a safety valve. It is also a warning. We have six major concerns.

Incomes are high, boosted by the terms of trade, which is fuelling profits and dividend growth, and by low levels of unemployment. Combined with remarkably subdued overall wages growth, this ensures that spending power remains firm. There are emerging shortages of skilled labour, especially - it seems - among CEOs and directors who are busy voting themselves massive increases. A spillover to the workforce in general cannot be ruled out. This is major worry number one.

Production continues to struggle to match the income measures. Only resources are thriving, and many extractive industries are constrained by the capacity of the ports and railways. The limit this places on export performance is major worry number two.

Leading indicators show renewed likelihood of fast growth in future. Equity prices have set new records even as housing activity returns to more acceptable - but still very high - levels. Despite recent subdued retail sales, the probability is that overall demand, and imports, will again be soon growing too quickly. This is major worry number three.

While overall inflation has remained tame, this is temporary relief. Domestic inflation is still running in excess of 4 per cent per annum and the prices of imported goods - including, but not limited to, oil - have been rising far faster than they were. China’s inflation, reversing many years of deflation, is providing a far less subdued global inflation background. This, with the risk of current account-induced A$ weakness, is major worry number four.

Amongst the policy levers, fiscal policy is still firmly set on stimulus, though the delay in the preparation in the mid-year fiscal update is clearly to allow some decent time to pass before Treasury declares, “Oops, the cupboard is bare”. Of course, if they then advise a tightening in fiscal policy, it will be welcomed by Henry Thornton but only because it would confirm our view that the previous opening of the budgetary spigots was economically wrong, no matter how politically correct. Expansionary fiscal policy is major worry number five.

Of all the economic developments, perhaps most corrosive over the last year has been the credit-induced surge in asset prices that has seen both sides of the economy’s balance sheet inflate. Data will soon be released by the Australian Statistician which will show perhaps the greatest increase in a year in the value of total assets deployed in the economy, but the increase will have come disproportionately from increases in asset prices, not from the honest toil of fixed capital investment. This has been created by a massive monetary policy mistake, a mistake we have been warning about consistently in this column. This asset and credit inflation is economic worry number six.

We are well aware that our views are not those of the mainstream, but we would be enormously surprised if the econocrats in Treasury and the Reserve bank did not share our concerns, perhaps to a high degree. Of course, the econocrats are not able to speak out.