Reserve should hold rates - for now

These caveats to the picture of a stronger than expected economy, plus considerable uncertainty about the strength and timing of economic recovery, should give the central bank's board sufficient reason not to begin tightening monetary policy today.

However, inflation, broadly defined to include asset inflation, needs careful attention. While actual goods and services inflation is within the Reserve Bank's target zone, both underlying goods and services inflation and inflationary expectations are above the target zone and possibly rising.

Furthermore, continued asset inflation, including the apparent recovery in house prices and further increases in equity prices, are further warning signs that should be monitored closely by the Reserve Bank.

The Reserve Bank has indicated that it takes asset inflation into account, but not how it does this. It has said that "normal" cash rates are well above current rates - perhaps in the range either side of 6 per cent. This is consistent with the "Taylor rule" calculations presented by Henry in the first article in this series in June 2002.

Moving cash rates from 3 per cent to 6 per cent requires 12 25-basis-point increases or six 50-basis-point increases.

My advice for the board is to wait for another month. But if current trends persist, the move to a more normal cash rate of around 6 per cent should occur briskly and in 50-basis-point chunks.

If current good news trends continue, the first such chunk is likely next month.

Go early, go hard, go rates.