As it meets today, the Reserve Bank would be wise to decide sit on its hands for a bit.

However, if wages begin to surge, all bets will be off and the Reserve Bank will need to hit the economy with additional rate hikes until people demanding wage increases get the message.

Henry has been accused of going soft and running up the white flag but is duty bound to call it as he sees it.

Henry assumes that Reserve Bank Governor, Glenn Stevens, has woken up to the dangers of religiously enforcing his 2-3 per cent inflation target by driving the economy, or at least large parts of it, into recession.

But now the unions, and perhaps Julia Gillard, need to get the message.

The global economy is in trouble.  It is not just the US recession, if that is what it is.  It is not just Euro-sluggishness, which is endemic.  Nor the chronically weak Japanese economy.

Rocketing food prices on top of very high commodity prices including the painfully high price of oil has the capacity to do enormous damage.  Poor people everywhere are becoming malnourished or in extreme cases are starving.  Food riots in refugee camps add up to the tip of a large iceberg, yet the global boom has slowed only slightly.

It is common to talk of a two speed economy in Australia.  Now the global economy is divided into fast and slow streams and eventually those in the slow stream will object sufficiently strongly to matter.

Long-standing protectionist agricultural policies have been made far worse by massive, misguided subsidies for crops that can be used as bio-fuels.  The net effect is reduction of food-producing land at a time when wealthy people in booming third world economies are demanding better quality food.

Glenn Stevens and his colleagues at the Reserve Bank can do nothing to alleviate the global food crisis.  His colleagues in other central banks can do very little to mitigate the dysfunctional global agricultural system, although Ben Bernanke and Jean-Claude Trichet might just be able to influence a political leader or two.

What central bankers can do acting in concert is to avoid turning a global slowdown into recession that would multiply the misery of poor people everywhere.  Glenn Stevens might just pass on this message to Ben and Jean-Claude.  More relevantly, he can see to it that Australia does not suffer recession by continually tightening monetary policy in pursuit of the outmoded nostrum of targeting goods and service price inflation at a time of vast global commodity inflation.

Henry's logic is simple, and we assume now widely understood.  Lack of downward flexibility in most prices makes it impossible to offset sharp rises in some prices (oil, food, rents in Australia) by equally sharp falls in other goods and services of offsetting importance in the overall "target" inflation measure.

The board of the Reserve Bank will not spend too much time discussing the global economic circumstances beyond the regular current economic conditions report.  US-Euro-Japanese sluggishness will be noted.  So too will the continued China-India-emerging nations boom.  The latest news includes reports of further massive hikes in the prices of coal and iron ore and governmental discouragement of China Inc.'s attempts to buy up Australian resource companies.

The graph plots the Reserve Bank's commodity inflation measure against the exchange rate between the $A and the $US.  Clearly the powerful rise in commodity prices has influenced the Australian currency, and movement to parity and beyond will reduce some exports and encourage some imports, and weaken Australian manufacturing.

The domestic economic indicators will be examined closely.  Retail sales have slowed, perhaps far closer to a sustainable 3 per cent real annual rate than the near 6 per cent rate of the last half of 2007.  Credit growth has slowed, although on the broadest measure only to an annual rate of 14 per cent or so.  Housing approvals fell sharply in March and house prices are said to be falling in most cities.

Household and business confidence has fallen and this helps to explain slower retail and housing demand.  And the ripples from Australia's margin-lending scandal (an antipodean sub-prime event) are putting a crimp in the spending of former high-flying entrepreneurs.

Next week's budget is expected to contain some real cuts to overall government spending (to its growth if not absolutely) as well as continued strong revenue growth.  A budget surplos of 2 per cent or more of GDP is possible and would gain the commentariat's approval.  However, the onset of promised tax cuts will provide an offsetting influence and the Reserve bank will not assume the net effect of the budget will be to slow the economy further.

Business investment is still strong, and infrastructure spending by all levels of government will bolster this effect.

The demand for skilled workers is holding up, although there are anecdotes of slowing demand and greater supply in the semi-skilled sector.

Henry's main economic concern relates to the labour market.  With an over-heated economy and powerful demand for labour, a wages surge would in times past be underway by now.  The wage explosions in the 1970s, the early 1980s and the early 1990s all did great damage.

The Hawke government had the Accord - which involved voluntary restraint by workers and, when the chips were down at "Banana Republic" time, a cut in real wages.

The Howard government had Work Choices.  Unfair? - yes in some cases, and this unfairness cost the Howard government dearly.  Ineffective? - by no means, if the aim was to maximise jobs rather than pay and conditions.

There is no doubt in Henry's mind that the tough aspects of Work Choices helped to restrain wage demands as the resource boom gathered pace.

Substantial help was also given by the ready importation of skilled labor with the help of 457 visas.

But now, although the economy is slowing, there is a lot of pent up demand for wage hikes - particularly in the protected public sector - that could spread the resource sector pay pressure to other parts of the economy.

Where the resources boom is hottest, Western Australian public servants are due to rally this week for a 23 per cent pay rise over three years. Victorian teachers want 30 per cent over three years. University general staff are after 9 per cent for one year.

There has been the huge spectacle of the power privatisation showdown in NSW, a clear test of the strength of organised labor against political Labor in government.

How these demands are handled will do much to determine the degree to which the economy slows and therefore the fate of the Rudd government.

These issues will occupy the minds of RBA board members today.

Henry's general point about the desirability of suspending inflation targeting will doubtless be put aside for the usual reason - "Not invented 'ere, gov'nor".

But there are enough reasons apart from this for the Bank to stay its hand.  The economy is slowing, confidence has taken a big hit and a moderately firm budget is in prospect.

There can be no guarantee that further rate hikes are off the agenda.  But further imported inflation is no good reason for continued rate hikes.

If wage inflation remains contained, current interest rates and a firm budget may do the job of sufficiently slowing the economy to contain domestic inflation. 

A wages surge would mean all bets were off.  Over to you, Julia Gillard.

Published today in The Australian.