Thursday, January 24, 2008

What's the Reserve Bank going to do?

Don't doubt for second that the Reserve Bank is worried, deeply worried about yesterday's truly shocking inflation news. And not worried just because the rate is high – higher than it has been in 16 years – but also because this time the rate is trending up.

You can get an idea about how quickly the inflation has snuck up on the Bank by going back to its inflation forecasts released in November. Then it was warning that underlying inflation would end the year at 3.25 per cent. In fact it has ended the year at close to 3.5 per cent and rising.

In all but extraordinary circumstances the Reserve Bank board would be pushing up rates when it meets in twelve days time...

But right now it finds itself in extraordinary circumstances. World stock markets have been in free-fall, and it is not yet certain that they've stopped.

On-one seems to have a handle on what's happening to international financial markets or why.

Until it gets a handle on what's happening the Bank would prefer not to pull hard on the only lever it has.

Fortunately it has twelve days to wait for the smoke to clear.

If the smoke does clear in time and it becomes apparent that markets are no longer at risk and the stuffing hasn't been knocked out of the Australian economy the Bank will push up rates.

If there is still uncertainty – if, as now, no-one much has a clue what is going on - it will reluctantly wait.

But only for as long as it needs to.

As soon as the smoke does clear and as soon as its knows that the stuffing hasn't been knocked out of the Australian economy the Reserve Bank will act.

We will face a rate rise unless we face something even worse first.

And who's the blame? The Treasurer Wayne Swan says it's not him. He's right.

But perhaps its not the other lot either. His opposite number Malcolm Turnbull said yesterday that inflation was the “inevitable consequence of a strong economy”.

We've done it to ourselves by spending with such enthusiasm that retailers have felt little need to pass on the benefits they've been getting from the higher dollar.

We haven't cared about cheap prices.

As soon as the smoke clears, the Reserve Bank will make us care.