We could face more rises in interest rates if inflation doesn't behave and fall the way the Reserve Bank wants it to.
In the statement issued with yesterday's 0.25% rise in the cash rate to 7%, the bank was unusually direct in its warning
"In future meetings the Board will continue to evaluate whether the stance of policy will be sufficiently restrictive to return inflation to the 2-3 per cent target." a clear threat to lift rates again.
That's unusual language from the bank: it's making clear the inflation question will be revisited every meeting from now on and a decision could be expected after any of those.
A further ominous sign was the statement that a "significant'' slowing in demand is likely to be necessary to get inflation down.
"A significant slowing in demand from its recent pace is likely to be necessary to reduce inflation over time."
What is 'significant" and just how many times rates will have to be lifted before it is apparent the policy stance is "sufficiently restrictive' is unknown. The bank isn't saying.
But we will only know if this latest increase is enough if inflation starts falling. And the bank won't take one quarter of falling inflation (as measures by the Consumer price Index and its own measures), it will want two, perhaps three quarters to make sure the decline is sustained and the rate is back safely inside the 2% to 3% range.
The market fell 70 points by the close, after being down around 40 points just before the announcement at 2.30 pm.
Before the decision, the National Australia Bank said there was a 40% chance of a second rate rise this year. With this statement, the odds have firmed.
The Bank said in its statement that expects the already high levels of inflation to further increase over the rest of this year before easing in 2009. So the first rate cut might not come until well into next year, or 18 months away.
It was the first decision from the bank under its new system of announcing the decision the same day as the board meeting was held. Minutes from this board meeting will be released on February 19.
The decision was expected with all 27 economists surveyed by Bloomberg yesterday saying they expected rates to rise.
The bank made it clear the rise inflation in the December quarter (as shown by its own measures and the CPI) was a driver.
"Recent information points to significant inflation pressures. CPI inflation on a year ended basis picked up to 3 per cent in the December quarter, with underlying measures around 3½ per cent," the bank said in its first statement accompanying a rate increase.
"This was a little higher than was expected a few months ago. Indicators of demand remained strong through the second half of 2007, and reports of high capacity usage and shortages of suitable labour persist.
"In the short term, inflation is likely to remain relatively high and will probably rise further in year ended terms, though the Bank expects it to moderate somewhat next year.
"The Board took careful note of recent events abroad and developments in financial markets.
"The world economy is slowing and it now appears likely that global growth will be below trend in 2008. Recent trends in world commodity markets suggest, however, that Australia's terms of trade are likely to rise further.
"The pressures in short-term money markets seen late last year have eased in recent weeks, but sentiment in international capital and equity markets remains fragile. In Australia, financial intermediaries have passed on higher costs to their customers over the past couple of months. There has also been some tightening of lending standards to risky borrowers, a process which may yet have further to go.
"These developments, together with the effects of earlier changes to monetary policy, can be expected to exert a moderating influence on private demand in Australia over the period ahead. But given the extent of pressure on capacity and the build up in inflation, a significant slowing in demand from its recent pace is likely to be necessary to reduce inflation over time.
"Having weighed both the international and domestic information available, the Board concluded that a tighter monetary policy setting was needed now. The Board will continue to evaluate whether the stance of policy will be sufficiently restrictive to return inflation to the 2-3 per cent target."
So the volatility on financial markets last month was not a worry for the bank, nor was the idea that the US economy was tipping into recession.
But we got a timely reminder that the volatility hasn't gone away with the news of a downturn in the vital US services sector to recession-like levels. That saw markets in Europe and the US drop by more than 2% and gloom again set in. It will be a rough day here.
If anything the RBA decision confirms the strength in the Australian economy is very real, positive, but very worrying.
But we have to understand that one of the indicators the bank will be looking for confirmation inflation is slowing, is a rise in unemployment and a drop in the strong job creation we have seen over the past two years or so. Employment is a lagging indicator and it could be rates will start falling as unemployment rises.
But with strong house prices, there're problems for the banks. Do they follow the RBA up, or do they leave rates unchanged, or move them part of the way up. After all rates rose in a one-off series of moves in January by between 0.12% and 0.20%.
