RBA lies low as inflation rears

Of course, deep down, the board is probably not so solely concentrated on inflation. Real activity and demand matter too and the news has not been good.

The March quarter GDP data was dreadful. The economy struggled to expand 0.7 per cent in the quarter, but only through a boost to inventories that contributed 1.2 per cent to overall growth. Among the few sectors to expand - and contribute positively to growth - was transport and storage, truly reflecting an inventories-led recovery. The "sector" with the next biggest contribution to growth was the statistical discrepancy! This ephemeral recovery from the dismal December quarter will naturally reverse in the June quarter. The outlook for farming in eastern Australia has deteriorated, too.

But a range of business and consumer indicators suggests that it is not time yet to slash one's wrists.

Lower than normal interest rates have allowed building approvals and credit growth to bottom out. Even house prices in Sydney and Melbourne - which had been falling in nominal terms - may soon stabilise, while the boom in the resource states will continue.

The key seems to be keeping the large numbers employed in a job. With profits high - though passed their cyclical peak - and skills in short supply, businesses are investing and seeking to retain staff.

Abroad, economic conditions have not changed much, and not clearly for the worse.

Bond yields globally have declined, equities are rallying (except where there are downwards earnings revisions) and sentiment seems to be moving towards a lesser rise in US short-term interest rates in the next few months.

The US economy is the opposite of Australia's - growing well and sustaining firm productivity growth - even though we of course prefer the Australian situation with a fiscal surplus (no matter how modest) over the US's big fiscal deficits.

Japan and the euro area seem to be muddling through, growing more slowly than would be desired. Both have exchange rates that are now more favourable for growth than before. China is holding up well and is, if anything, taking growth from the rest of Asia. Overall, China is having a big deflationary effect on the rest of the world as it opens up to global trade. Savings remain too high in Asia, though we find it encouraging that Thailand - the first into the crisis in 1997 - has finally recovered fully and is now again running a current account deficit. Yes, sometimes a current account deficit can be a badge of pride.

In Australia's case, the current account deficit in the March quarter should be a matter of national concern. At more than 7 per cent of GDP it has taken on traditional pre-crisis dimensions. But the central bank has convinced itself that the deficit is not its problem and the central Government has decided to set fiscal policy in a smoothed medium-term manner with no effort to lean against cyclical excesses.

So the current account deficit has been encouraged to balloon, until either fortuitous commodity price increases ride to the rescue (temporarily) or the private sector pulls its head in - something it will only do in a crisis.

To be fair, the April trade account showed a big rise in exports and a marginal fall in imports. This is no signal for celebration but it is at least a sign that Treasury's forecast of a substantial improvement in Australia's current account deficit in 2005-06 is plausible if demand can be restrained.

Until something flushes it out of its burrow, we expect the RBA board to stay hunkered down, out of the spotlight, staying quiet even as actual and forecast inflation deteriorates.