The case for a pre-emptive strike

Unemployment is below 5 per cent of the measured workforce and seems still to be falling. Skilled labour is hard to get, and the Fair Pay Commission, in its first decision, saw fit to award almost the full amount demanded by the ACTU.

Despite this decision ignoring the Government's submission, Prime Minister John Howard described it as an act of "genius".

Various measures of business confidence are weakening, except for the resource companies and some parts of the service sector, which remain in boom-time condition.

Clearance rates for home-auctions are strong and housing approvals have shown signs of recovery.

The banks and resource companies are producing record profits and share prices continue to set new records. Overall, Australians are accumulating wealth at rates not seen since the gold rushes of the 19th century.

Inflation is the joker in the statistical pack.

The June-quarter consumer price index (CPI) shocked with an annual increase of 4 per cent. This was correctly ascribed in part to large increases in the prices of petrol and bananas. "Underlying", or "core", inflation, it was pointed out, was at 2.9 per cent, still (just) within the target zone of 2-3 per cent.

September's CPI provided an even bigger shock. Overall, or "headline", inflation was slightly lower, at 3.9 per cent. This was only a slight reduction, which immediately sounded an alarm.

But when the measures of "core" inflation were published shortly afterwards by the Reserve Bank of Australia, the shock was palpable. The so-called "trimmed mean" rose by 2.9 per cent and the "weighted median" rose by 3.2 per cent.

These two measures of "underlying" inflation have risen inexorably since late 2005. These increases were well above those expected by the econocrats of treasury and the Reserve Bank, and leave them sitting very uncomfortably in relation to the 2-3 per cent inflation target they have embraced so enthusiastically.

Whether gradual and drawn out, or larger and pre-emptive, increases in interest rates will inflict real pain. For most Australians, this pain can be coped with, and provides valuable lessons about risk management to those who take note.

For the poorer members of society, including many farmers badly hurt by drought, the pain will be bad, and in some cases intolerable.

Social policy must alleviate the pain, as it already is doing, to some extent, for struggling farmers.

Holding back necessary tightening of monetary policy would be a bone-headed response to a real problem.

My considered view is the 50 basis points now (accompanied by relevant assistance for those who need help) would be the policy most likely to minimise the overall pain of getting the Australian economy under control again.