Australia’s underlying inflation has been creeping up since early 2001.

The big falls in the rate of unemployment have enabled the overall misery index to creep down notwithstanding rising inflation. This was the theme of last month’s contribution to the work of the board of the Reserve Bank, which meets again today.

Inflation for the December quarter surprised in being lower than expected. This outcome came as a relief to many people – equity traders, bond holders, people with mortgages who had feared further hikes in interest rates, Reserve Bank officials and members of the government. For all these groups, the misery index turned down. The CPI release contained such a beautiful set of numbers one was tempted to imagine intervention from on high – clearly impossible in a non-banana non-republic.

This month we attempt to measure happiness at the Reserve – a difficult task as central bankers are special people trained from birth to hide their emotions.

The past year has seen signs of rising inflation and a consequent erosion of the Reserve’s happiness. Continued strong jobs growth has meant that the Reserve has no strong reason not to raise cash rates relatively rapidly and it is that surprise result for the December quarter that has stayed its hand so far in 2007.

Since the Board of the Reserve last met, the world economy has performed well. The recent market meltdown produced words of comfort from the great and the good, and the consensus seems to be that we are in for another year of strong global growth with inflation lower, mainly because many central banks have raised interest rates.

The RBA already seems happy with the current economic conjunction, and describes the risks for inflation as “equally balanced”.

Henry is less relaxed and comfortable than this. There are three real upside risks for inflation – wage push inflation, oil price inflation and nuclear war inflation. This is why we called for pre-emptive action late last year and continue to see the need for at least one more rate hike this year.

Read more at Henry Thornton.