The Economy: Europe Interrupts The Boom, RBA Sees Gloom

So what can the Reserve Bank do as it looks to the next board meeting on Melbourne Cup day and assesses the country's economic position and whether to cut interest rates?

The inflation figures for the September quarter that are out a week today will play a major influence and will probably be good.

So rate cut looms?

Well maybe, but perhaps not solely because the Australian economy is weak. It's not and if anything has shown signs of being stronger than thought since the last RBA board meeting.

No, there is another reason why the RBA might be tempted to cut and that is the continuing concerns about Europe, especially if there is no real progress at next Sunday's EU leaders summit, as it now seems there could be.

Those worries at the RBA were again made clear (for the third month in a row) in the minutes of the October board meeting, released yesterday.

Since the RBA board meeting on October 4 we have had a couple of weeks in fantasy land where the markets believed that the Europeans would quickly get their tangled financial woes in order.

Led by Europe and Wall Street, markets rebounded, the Aussie dollar rose sharply and commodities like copper and oil were back in demand, despite growing fears about the health of the Chinese economy.

Monday saw a big rally in Asia (including Australia) after a solid jump last Friday in the US and Europe and the Group of 20 Finance ministers meeting in Paris which told Europe at the weekend to have a plan ready by the EU leaders' summit next Sunday on how it would handle the financial mess, especially Greece's still weak position, and the capital needs of EU banks.

Markets love deadlines and everyone it seems was convinced that everyone in the eurozone and the EU were heading in the same direction.

But that all ended in a welter of contradictions from Germany on Monday night, our time, with Chancellor Angela Merkel and Finance Minister Schaeuble telling the world different things.

Mr Schaueble said that an ultimate solution to the crisis would not be presented at the upcoming European Union summit and a spokesman for Ms Merkel said people were getting ahead of themselves if they thought this would happen by Sunday.

Moody's surprised with comments in its report on the French economy that contained both good and bad news.

Moody's said triple-A rated France had "ample capacity to absorb shocks" but warned at the same time that "global financial and economic crisis has led to a deterioration in French government debt metrics - which are now among the weakest of France's triple-A peers".

Moody's said it would continue to "monitor and assess" France's credit rating which has been the focus for markets since the US lost its triple-A rating in August.

The good news was that the AAA rating remains intact, but France is on an early warning.

Investors worry that the stronger eurozone economies' commitments to bail-out to weaker ones, such as Greece, and stand behind EU banks could see their own credit ratings weakened.

So after that flurry of negatives down went Wall Street, and Europe and Australia followed as the dollar dropped as well.

So it's 'risk off' for financial markets after a couple of weeks of improving 'risk on' conditions.

The local economy does look better according to the flow of data since the start of October, but all that could be undone by Europe's problems as the minutes noted:

"Conditions in global financial markets had continued to be very unsettled, with uncertainty increasing about both the prospects for resolution of the sovereign debt and banking problems in Europe and the outlook for global economic growth.

"This had been reflected in falls in measures of consumer and business confidence in the major economies, and it was likely to weigh on spending and growth in these economies.

"This could spread to other regions, but so far indications were that economic activity was continuing to expand in China and other parts of Asia.

"Overall, recent events had led forecasters to reduce their estimates for global GDP growth.

"Prices for commodities had also declined over recent weeks, although they remained relatively high.

"Domestically, there continued to be large differences in conditions across sectors.

"Investment in the resources sector was picking up very strongly and some related services sectors were experiencing better-than-average conditions. In other sectors, cautious behaviour by households and the earlier rise in the exchange rate were having a noticeable dampening effect.

"The impetus from earlier Australian Government spending programs was also abating, as had been intended.

"While there remained good reasons to expect solid growth over the medium term, indications were that the pace of near-term growth was unlikely to be as strong as earlier expected, reflecting both local and global factors, including the financial turmoil and associated effects on business confidence.

"With labour market conditions now a little softer, the likelihood of a significant acceleration in aggregate labour costs was lessening.

"These developments, together with new data showing that the pick-up in underlying inflation had been more gradual than initially indicated, suggested that the medium-term inflation outlook may now be more consistent with the 2-3 per cent target.

"Further data on inflation would be available later in the month.

"Members believed that an improved inflation outlook, if confirmed by further data, would increase the scope for monetary policy to provide some support to demand, should that prove necessary.

"Members noted that financial conditions had already eased somewhat, with interest rates for some housing and business loans declining slightly because of increased competition and the fall in funding costs in financial markets.

"The exchange rate had also declined somewhat from the very high levels of a few months ago.

"Taking all these factors into account, members considered that the existing stance of policy remained appropriate.

"That assessment would be reviewed based on developments in international financial markets and on further data on economic activity and prices ahead of the Board's next meeting."

Judging by those comments and the overall tone of the minutes which were more 'dovish' in that there were few worries advanced on the strength of inflation, wages, demand or consumption, a rate cut is very much in prospect.