Reserve opts for easy does it

YESTERDAY'S quarter of a percentage point rise in the cash rate to 3.5 per cent was about as good as it could have been for the markets as they look for equilibrium after the recent sell-off.The decision not to boost the cash rate by a half a percentage point combines with some carefully calibrated words from the Reserve Bank to ease concerns that it is putting the brakes on too quickly. And the language in the rate rise announcement is as comfortable as it has been since the global crisis peaked a year ago.The key comment in yesterday's announcement, recycled from the Reserve's statement a month ago when it lifted the cash rate from 3 per cent to 3.25 per cent, was that with the risk of a serious economic downturn in Australia passed, it is "prudent to lessen gradually the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker".That defuses a comment Reserve Bank governor Glenn Stevens made in Perth on October 15, that the Reserve had cut rates rapidly in response to the threat of the crisis, and would compromise its monetary settings if it were too timid to lessen the stimulus in a "timely way" as the threat passed.Stevens' Perth speech was interpreted by some as a pointer to a half-a-percentage-point leap at yesterday's meeting. Instead, the Reserve has reinforced the idea of rates only rising gradually, and repeated that it is in the process of lessening the stimulus that low rates are providing, not eliminating it.One conclusion is that on the basis of what it sees right now, the Reserve has not decided on a several-month sequence of rate rises to mirror the five consecutive rate cuts it announced between September last year and February this year (a final 25-basis-point cut in April took the total reduction to 4.25 percentage points).Nor is it signalling that it is definitely plotting a path that returns the cash rate fully to a neutral position — that is, one neither stimulating growth nor detracting from it.And neutral policy in the post-global-financial crisis will be reached with a lower cash rate than was needed before the crisis.As businessday columnist and Grattan Institute productivity growth program director Saul Eslake observes, the cash rate is a means to an end. It is moved around by the central bank to influence the cost of money in the real world, and as the buy-sell spread that the banks are taking on loans has increased by between 100 basis points (mortgages) and 230 basis points (small-business loans) since the crisis began, rate neutrality can now be achieved with a lower cash rate.A cash rate of between 5 per cent and 6 per cent was neutral ahead of the GFC. Post-crisis, it is arguably 4 per cent to 5 per cent, and with the cash rate now at 3.5 per cent, the Reserve is already closing in on the bottom of that range.The atmospherics of yesterday's statement were not totally sunny, but they were definitely fine, and miles away from the language used after the same meeting a year ago, when the Reserve cut the cash rate by three-quarters of a percentage point.The markets were "turbulent", it said then, share prices were "volatile", economic data pointed to "significant weakness in the major industrial economies" and slowing activity in the developing world and falling commodity prices were having a "dampening influence".Inflation was then still running stubbornly hard, at 5 per cent on the headline measure and a tick over 4.5 per cent underlying. But the Reserve said slowing demand would lead to declining capacity utilisation that would team up with "global disinflationary forces" in the crisis to pull inflation down over time, even as the plunging Australian dollar worked in the opposite direction, and said it would continue to "make adjustments as needed" to promote sustainable, low-inflation growth.Nobody believed then that the Reserve and its equivalents overseas were on top of situation. Wall Street's Dow Jones Average fell 5 per cent the day after the meeting, and by November 20 had shed 2073 points, or 21.5 per cent of its value. Australia's S