THE Reserve Bank wanted low inflation. Now it's got it. Strip away the statistical static, and for the last three quarters, underlying inflation has been running at 1.8 per cent, the lowest level for almost 50 years.
But in 1963-64 we had the best of both worlds: inflation of 0.9 per cent and growth of 7 per cent. Now we have growth of just 2.5 per cent, and most of it in outback mines. The 80 per cent of the economy not driven by mining is treading water.
This is not what the Reserve forecast. It thought the economy would be booming, and inflation around the top of its target band of 2 to 3 per cent. Instead, mining is booming, the rest of the economy is flat, and since mid-2011, underlying inflation is below the bottom of its target band.
The Reserve made a mess of it. It kept overestimating growth. It kept overestimating inflation. It raised interest rates far too high, and has kept them too high. It has no more excuses. It must now fix the problems it created.
Next week it has two choices. It can cut its losses, fix the problem quickly, and move on to the next page. That means cutting interest rates by at least 0.5 percentage points now, and by more ahead if the economy continues to underperform.
Or, if its priority is to preserve its pride, it could make just the usual cut, of 0.25 percentage points, and go on issuing rosy forecasts as if nothing had gone wrong. That would be irresponsible, but not unlikely.
The economy needs a decisive lift; a small rate cut will not give it. Mortgage rates are now at 2005 levels, appropriate for an economy growing fast. Small business overdraft rates are at late 2007 levels, appropriate for an economy overheating. Now we are slow, and cold. Even a 0.5 percentage point cut assuming the banks pass it on would still leave rates too high.
We've now had three quarters of inflation data since the Bureau of Statistics updated its index weights to reflect actual household spending. In that time, in annualised terms, headline inflation has grown at 0.9 per cent; seasonally adjusted inflation at 0.7 per cent; and underlying inflation (the trimmed mean) at 1.8 per cent.
There were times in the '90s when inflation got as low as that, but only because the index was then dominated by mortgages, so rate cuts also cut inflation. This time prices have been flattened by three things: falling fruit and vegetable prices, the high dollar cutting import prices, and the weak economy cutting retail margins.
Yes, say inflation hawks, but look at the prices of non-tradeable items: up 1 per cent in the March quarter, 3.6 per cent in a year. The Reserve can't relax its grip, because if the dollar falls, these will drag inflation back up.
Relax, hawks. The March-quarter figure is high because it includes the annual rises for health and education fees. The annual data matters. But it shows six items created 80 per cent of net price rises in the past year and not one is an area where prices are sensitive to interest rates.
The six are rents (up 4.4 per cent in the past year), health and medical services (5.1), petrol (5.9), electricity (9.9), private school fees (6.0), and cigarettes (6.3). High interest rates did not stop these prices soaring in 2007-08, or in 2011-12. If you stop to think about why, the reasons should be obvious.
The Reserve has run out of excuses. It was wrong. It needs to cut its losses and move on.
