The case for a pre-emptive strike

"Too little, too late" is Henry's considered view about monetary policy in Australia. This view seems to be catching on more widely, with market participants saying this month's rate-hike is "virtually certain", and increasing the odds on at least one more hike next February.

As a famous central banker, the late Austin Holmes used to say of such adjustments: these folks are "stumbling reluctantly toward the truth".

There are mixed signals from the real economy, as we shall discuss. But the key point is that "core", or "underlying", inflation is rising steadily and reached the top of the target range in the September quarter. Unless this trend is reversed, Australia's hard-won reputation as a low-inflation economy will be put at risk. Indeed, it already is.

There is a strong case for a pre-emptive rise in cash rates of 50 basis points. This might just jolt inflation expectations back into the zone of relative stability, and thus protect a fundamental pillar of the strong economic prosperity enjoyed by Australians for the past 15 years.

The more likely outcome of today's meeting of the Reserve Bank board is the widely expected 25 basis-point hike. The risk is, that decision would not have much effect in curbing inflation, meaning more debate and further rate hikes well into 2007.

The political fallout from this would be ugly. Although the Reserve Bank board should, of course, ignore such a matter, Henry and his readers in Canberra need not.

The global economy has experienced offsetting forces in the past month. In summary, the US economy has weakened while the Chinese boom has possibly strengthened. The net effect is that the price of oil has fallen substantially, reducing one of the main risks to continued strong global growth.

There is in fact concern at the highest levels of international policy-makers over China's ability to contain its boom, and continued double-digit Chinese growth will ignite inflation there. Chinese inflation would reverse the great global force of Chinese deflation, removing a powerful anti-inflationary force from the global economy.

The world has also, quite suddenly it seems, realised that global warming is a massive threat to continued growth and that adjustment to a more sustainable future economic path must begin soon, or it could be very painful. Despite the fall in oil prices (which might, in part, be a response to lesser perceived geopolitical threats), the overall situation in the Middle East remains parlous.

So the global background continues to feature strong growth, but with more of an inflationary bias than we have seen for the past 15 years.

Australia has experienced mixed economic trends. There is the distress felt by farmers as the worst drought in a century or more tightens its grip. Retail sales seem to be slowing, suggesting that, on average, households are tightening their belts, and the poorer members of society are hardest hit. But overall credit growth is still far too high, especially growth of credit-card debt.

Employment growth remains strong, and casts into doubt the relatively subdued growth of real GDP.