Reserve may stay its hand amid glimmers of hope

Optimists, including US President Barack Obama, claim to see the green shoots of recovery.

This might keep local interest rates on hold today, along with the convention - if this is still observed - that it is important not to implicitly challenge the budget by moving rates immediately before its presentation.

In the mighty US, consumer sentiment improved in April. The Institute for Supply Management's manufacturing index rose to 40.1 last month, up from 36.3 in March and ahead of expectations. While readings under 50 indicate contracting activity, the report suggests the pace of decline is slowing.

Manufacturing inventories fell again in March for the seventh month in a row. Declining inventories mean that production is less than consumption, providing the potential for restocking.

The safe conclusion is that the pace of decline seems to be slowing.

US share markets have continued to rise, in what is beginning to look to optimists more like anticipation of recovery than a bear market rally.

The International Monetary Fund has had the embarrassment of five times revising down its forecast of global economic activity. So one expects especial care in spotting improvement.

A little over a week ago, Youssef Boutros-Ghali, who chairs the IMF's steering panel, the International Monetary and Financial Committee (IMFC), was reported as saying: "We have serious problems. We are taking very serious measures, but things are beginning to look up.

"Carefully, cautiously, we can say there is a break in the clouds," said Boutros-Ghali, echoing the guarded optimism expressed by other worthies.

An IMFC communiqué added that to ensure recovery in 2010, further action would be needed to restore the health of banks, revive lending and restart international capital flows. It urged countries to keep up fiscal stimulus and develop plans to exit from the extraordinary measures taken once recovery was established.

The health of banks remains the biggest obstacle to recovery and the biggest risk of further, possibly dramatic, deterioration in the economic outlook. The US banking system looks less dire, though it seems there will be nothing much left of the mighty American International Group when the sales of its better business units are over.

It is the European banks that could still cause a dramatic worsening of the global outlook. Of the $4 trillion in bad loans estimated by the IMF, at least $1 trillion is owed to the European banks, much due to failure of businesses and nations in Eastern Europe.

With no strong European government and a relatively new untested European central bank, one wonders how forced marriages and bailouts of European banks will be arranged.

Further, jobs are still being lost everywhere, and people who lose their jobs usually lose confidence and are forced to tighten their belts, causing the downward spiral of activity diagnosed so lucidly by John Maynard Keynes a little over 70 years ago.

There is not much the Reserve Bank or the Australian Government, can do about the global recession. Neither can either body contribute significantly to the global recovery.

The good news for Australia is that, with the application to the banks of the Government's triple-A credit rating, there is no real cause to doubt the solvency of these banks.

Despite Australia's "miracle economy" status, jobs are now being lost at an alarming rate. Clearly, globalisation means that many decisions are made in the global centres of power, rather than in Australia's boardrooms.

The alarming corollary is that economic policy decisions here may not much influence the state of the Australian economy. The best monetary and fiscal policies - somehow defined - may not help much at a time of general global panic and lack of confidence.

The caveat to this cheerless conclusion is that bad decisions can make matters worse. Australia has a very large net external debt, at last count approaching $700 billion, or about 70 per cent as a ratio to GDP.

With budget surpluses and zero net domestic debt, there was little chance of international investors transferring capital out or the run on the Australian dollar that would create. Now, however, there is a budget looming that will show a very substantial deficit, perhaps of the order of $50 billion, or even higher, according to some pundits.

The swing from last year's $20 billion surplus is dramatic, and is sure to catch the attention of those screen junkies who put thumbs up or thumbs down as each nation releases important economic information.

Reserve Bank governor Glenn Stevens has been careful to avoid any suggestion of disagreement with the Government.

I refuse to believe he really believes handouts to all and sundry (including Mrs Thornton), paying for pink batts in people's ceilings or painting schoolrooms, makes a lot of economic sense.

But Stevens is duty bound to go along with whatever the Government does, so long as he does not believe its actions represent a clear and present danger to economic stability.

There once was a convention that monetary policy action ahead of a budget might indicate lack of confidence in what the budget contains. Perhaps this has been junked, along with the convention that the central bank does not "vote" by changing interest rates during an election campaign.

There are two reasons for the Reserve to stay its hand today. There are those green shoots of recovery, added to which it would be prudent to leave room for further rate cuts if the economic outlook again deteriorates.

And there is the (possibly outmoded) convention of not indicating possible displeasure at the budget itself.

On the other hand, as they say, jobs are falling much faster than the Reserve Bank and Treasury predicted, which provides a strong contrary argument.

Whatever the decision, the governor's statement will make interesting reading, and his actions will speak far louder than his words.