Two main interpretations have emerged from readers of the Reserve Bank’s quarterly economic statement, released yesterday and linked here.

The first is that at least one more rate hike is on the way. The second is that the ripples from the US subprime mortgage will not derail the current global boom – she’ll be right mates.

The expectation of further rate hikes comes from the Reserve’s focus on the booming global and local economies and the fact that the Reserve has raised its inflation forecast to 3 %, at the top of its 2 to 3 % target range. Do I hear the sound of gentle applause, gentle readers?

The Treasurer was reminding us on national TV last night that the RBA’s target, provided by him, is meant to apply “over the course of the cycle”. “Phouey to that”, Treasurer, is the implied answer of the Reserve and its army of tame commentators and bank economists.

This tame army will now have endless debates about whether the next rate hike will come in December 2007 or early 2008 (the “Welcome Comrade Rudd” hike) or (gasp!) in October or November (the “goodbye Prime Minister and Treasurer” hike).

Like Chris Richardson on The 7.30 Report, Henry would be surprised if the rate hike came before December, but if it does readers will know that inflation is getting out of control. Note please a news item on China’s inflation in the year to July, 5.9 % if Henry read it right. We have argued before at the similarities of China now with Australia in 1971.

The currency undervalued and crawling slowly up, inflation on the rise and “explained” by special factors – in the case of Australia in the early 1970s it was hikes in the prices of potatoes and onions, in China now it is food generally.

There are of course many differences between Australia then and China now. But misdiagnosis of the sources of inflationary pressure and the wrong currency regime are two similarities.

Because Australia was (and is) so small in the global scheme of things, Australia’s mistakes then harmed only itself, and perhaps to some extent New Zealand and PNG. But China’s mistakes now have the prospect of causing immense damage on the regional and indeed the global economy.

Wall Street rose strongly on Friday night and was little changed in net terms on Monday night. Ripples from the subprime lending fiasco seem for the moment to be dying away.

Much risk remains, as financial institutions and hedge funds have played pass the parcel with a whole swag of dud loans and no-one can be confident about where they will end up and, therefore, what longer term damage will be done to financial and economic systems.

A lot of experts, including the Reserve Bank, have pointed out that nothing much has changed to the outlook for strong global growth with rising inflation, though the caveat about rising inflation is rarely emphasised. But no-one should forget that there is a massive adjustment yet to come.

To make global growth sustainable, American deficits and the associated growth of American debt has to slow and China’s surpluses have also to slow, To achieve this, China has to grow faster and allow its currency to float higher, while the US has to grow slower while its currency sinks further.

Current market turmoil reflects awareness of this issue as well as the subprime lending fiasco. Life is about to get a whole lot tougher for central banks.

Read more at  Henry Thornton