Reserve Bank should think for itself as inflation threat looms

Euroland shares followed Wall Street's positive lead last week, but so far it has seen the smallest interest rate cuts and relatively small fiscal stimulus.

Conservative sluggishness is the heritage of hyperinflation in the old world.

China is set to slow, and the People's Bank of China has cut cash rates aggressively, most recently last week by 1.08 per cent. Political leaders naturally fear the unrest if millions of newly industrialised workers lose their jobs and substantial fiscal expansion is also on their agenda.

Globally, the financial system is still fragile, with freezing of redemptions by fund managers (including hedge funds and private equity funds) the next predictable crisis point.

Retirees everywhere are facing substantial loss of wealth due to equity market weakness, but freezing redemptions will produce further trauma.

Surely not even the Obama team will find it possible to bail out hedge funds and other managed funds?

Relative to the major economic zones, the Australian economy looks relatively strong, although our banks and markets have been fully integrated into the global financial firestorm. Business investment is still expected to rise strongly, and credit growth has slowed, but far from catastrophically. Business and household confidence is low (though with some recent recovery) and there are substantial job losses in some sectors, despite official statistics apparently holding up.

Governments are increasing spending and the federal authorities are laying the basis for a possible "temporary deficit". Inflation is far too high, at 5 per cent, although inflationary expectations have fallen sharply. Temporarily at least, inflation has been put in the box marked "she'll be right, mate". But this cannot be the case forever, of course.

Sometime soon the Reserve Bank will again focus on its core task. It is to ensure that inflation is eliminated.

While there are credible fears of the economy slipping into recession, sharp rate cutting will be the name of the game.

Henry will not be surprised if there is a 100 basis point rate cut today. If the cut is only 50 basis points, this would be good news. It would signal that the Reserve thinks the economy is not sliding into recession, and it is again getting back to its main task.