Clear choice for Costello as RBA's dynamic duo jostle for the top job

Under incoming Chairman Ben Bernanke, Santa might be prepared to drop in at the Fed next year, but only if Bernanke does move quickly to get the Fed Funds rate into non-accommodative territory. A Fed Funds rate of 5 per cent seems appropriate, perhaps 0.5 above neutral and 1.0 higher than now. That would allow the US economy to slow and generate some spare capacity, but would not lead to anything resembling a recession.

Of course, what is happening in Australia also matters to our policy settings. We can't fail to wonder about the easing in monetary conditions that has occurred since the currency was let slide, even while the terms of trade have gone on rising.

The weak currency is doing wonders for unhedged exporters and it will usefully trim the profits of importers. So business fixed investment is booming. But, more worryingly, exports are lagging, retail sales are recovering, skilled labour is in short supply, wages growth is creeping up and the current account deficit is far too large.

The recent weak employment data reflects the temporary check to activity following the March 2005 rate hike. As a lagging indicator, employment growth is very likely to recover.

When we think of the inflation and wages data to come, we shiver. The new board member, Roger Corbett of Woolworths, should explain the divergence between his claim that Woolies' prices are up only 2 per cent over the year and the 10-15 per cent increases in many like-for-like sales prices in his stores.

In the remaining months that Macfarlane remains governor, we expect belated official rate hikes, and only if forced by the market. But before end-2006 we would expect Australia to follow the Fed, having to raise by 0.5 per cent in total (two 0.25 per cent hikes, well telegraphed to the market) from the present 5.5. per cent.

The RBA board may enjoy an early Christmas lunch today, as it decides inevitably to do nothing.