Stumbling reluctantly to the truth” is the state of play on inflation.

I quoted this old central banker’s saw back in November, when arguing for a preemptive 50 basis point hike in interest rates.

Now we learn from David Uren in The Oz that “Inflation puts rates fear in Coalition MPs.”

Back in November we sounded the political warning bell loud and clear, here and in the pages of The Oz. “There is a strong case for a preemptive 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 that decision would not have much effect in curbing inflation, meaning more anguished 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”.

Uren also notes that “… financial markets now are starting to give some thought to a nightmare scenario for the Government of another two or three rate rises this year”.

Gadzooks, this out-Henrys Henry! We sincerely hope it isn’t that bad, but with the strength of the labour market – indicative of bottlenecks and shortages of skilled labour in this economy – and continued strength in the global economy, the “nightmare scenario” is of course possible.

Of course, some of last year’s inflation was due to high petrol prices, which are now lower. Together with a higher exchange rate, this will take some pressure off inflation, which is why the game is not all over for the Howard Government.

“If underlying inflation is higher, however, a nightmare scenario is still possible. To guard against this, what can the Government do? The only option left for the Government is to announce, post-haste, a significant policy that will have a depressive effect on inflation — for example substantial cuts in Government spending and promises of continued contractionary fiscal policy. The popular Labor State Governments must then co-operate, even though they currently enjoy significant leads in yesterday’s Morgan Polls.”

While this may not have an immediate impact on inflation, it signals to voters that the Government is being proactive about the scourge of inflation, and not just allowing interest rates, to spiral.

Such an action would allow the Government to retain its economic credibility and, eventually, to rein in inflation.

More reading at Henry Thornton.

Peter Fray

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