In lifting official interest rates by 0.25% today, the Reserve Bank has rejected the Howard Government’s re-election platform, “Go For Growth” which is in every backdrop and bit of campaign literature. It did so in this sentence in its short statement explaining the reasons for the rate rise:

But growth in aggregate demand will, nonetheless, need to moderate if inflation is to be kept to 2‑3 per cent in the medium term.

And the paragraph reads in full:

During 2007, the pace of growth of demand and output has also increased. There are few signs of that strength diminishing as yet, and reports of high capacity usage and shortages of suitable labour persist. Growth in labour costs has been contained so far, and high levels of investment are adding to productive capacity in some sectors. The rise in the exchange rate will help to contain pressure on prices. But growth in aggregate demand will, nonetheless, need to moderate if inflation is to be kept to 2‑3 per cent in the medium term.

That’s the bank, led by the Governor and the head of Treasury, Ken Henry, telling both Mr Howard and the Opposition Leader and anyone in both parties who still believe in the magic pudding approach of “Go For Growth”, that this is a dangerous illusion and no longer relevant. This was the first election campaign rate rise and it was also the one where the main thrust and slogan of the incumbent government has been so thoroughly repudiated by the independent RBA.

What the bank says by using the word “moderate” is to see employment slowing, and the unemployment edging higher, away from the present 33 year low of 4.2%. The Prime Minister’s boast that he wants an unemployment rate with a “three” in front of it, is now off limits so far as the RBA is concerned. And if the new Government doesn’t bend to its will, rates will rise until growth slows.

And the bank left open the possibility of another rate rise, if this demand in the economy doesn’t slow. It dismissed the September quarter’s Consumer Price Index which came in at 1.9%, a rate Treasurer Peter Costello strongly argued for as a more accurate reading of the price pressures in the economy.

The bank demolished that specious line very quickly:

Inflation in Australia has increased. Underlying inflation was 0.9 per cent in the September quarter and close to 3 per cent over the past year.

The annual pace of CPI inflation was lower, but this reflected two very low quarterly results nearly a year ago, as well as recent changes to the treatment of child care costs. By the March quarter of next year, both headline and underlying measures of inflation are likely to be above 3 per cent.

Looking at the underlying rate in the June and September quarters, core price pressure by the RBA’s own measure is now running at an annual rate of 3.5%. And external stimulus will continue, with the Bank highlighting:

The world economy is still expected to grow at an above-average pace, however, led by strong growth in China and other parts of Asia. High global commodity prices remain an important source of stimulus to Australian spending and activity.

The high Aussie dollar is the only anti-inflationary thing left, apart from a rate rise. If inflation at both levels is above 3% in the March quarter CPI when that is released around Anzac Day next year, then a 7% cash rate will be assured, and if there’s no change by August, a 7.25% cash rate could very well happen.

The challenge for the new Government is to cut or postpone the $30 billion-plus in tax cuts by either using them as superannuation boosts or as part of a series of Future Funds. From what the Bank says we clearly can’t afford any more stimulus in the domestic economy. And what if the drought breaks and rural commodity prices rush higher as farmers re-stock and replant?

And the Bank believes the Australian economy and borrowers can afford a rate rise, even after the return of the subprime mortgage debacle and its undermining in confidence of US financial groups:

In Australia, the tightening in credit conditions resulting from the global turmoil has been less pronounced than elsewhere. Wholesale funding costs have risen a little compared with official rates, and some borrowers have experienced an increase in interest costs as a result, but the flow of credit to sound borrowers does not appear to have been impaired.

That’s the next penny to drop: watch which bank and lender tries to shuffle through higher than 0.25% rate rises for mortgages, credit card, margin loan, personal and car loans and lease costs, plus business finance. The banks have all been warning of the funding pressures and asserting their right to lift rates more than what the RBA does: let’s watch for the first to do it. Will it be Macquarie or Adelaide Banks, which have already lifted mortgage and other loan rates because of the funding pressures; or will it be one of the big five?

After all, the banks have all made the funding freeze a crisis: they had structure and investment policies in place that exploited the cheap and easy money regime to maximise profits and pay. Australian borrowers should not have to underwrite the recovery of their pending margins because of their participation in imprudent lending.

Peter Fray

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