There seems little doubt the Reserve Bank will increase rates when it meets tomorrow. Certainly the market has a move from 6.75 per cent to 7 per cent inked as near enough to a certainty.

In fact, it will be quite astonishing to see rates go up tomorrow in the face of a US recession and global economic slowdown.

And there are two things that the one third of Australian households with mortgages can blame for it: John Howard’s absurd desperation to remain in office last year, and the margin lending madness that gripped the sharemarket at the same time.

The former Prime Minister showered cash on voters in two big tax cuts in 2007 – in the budget and then again during the election campaign, which was roughly equalled by Kevin Rudd. Those tax cuts are directly responsible for Australia’s problem with inflation.

It is not the resources boom. Exports are actually the weakest part of the economy at the moment and have acted as a drag on growth.

Nevertheless Australia does have an inflation problem, as the new PM Kevin Rudd has been telling us all, and which does appear to justify a rate increase at tomorrow’s RBA board meeting. Core inflation has been steadily rising for two years and is now roughly 3.4 per cent, well outside the RBA’s target band.

As a result Treasurer Wayne Swan and Finance Minister Lindsay Tanner are in the ridiculous position of having to reverse the effect of unnecessary and damaging tax cuts with spending cuts that are even greater, so the budget surplus increases and fiscal policy does not conflict with monetary policy.

Even the unions are arguing for the tax cuts to be put into super.

Just as worrying for the RBA is the 24.3 per cent increase in business lending in the year to December, which, according to John Edwards of HSBC Markets, was faster than in 1988 when adjusted for inflation (21.3 per cent versus 20.2 per cent). In fact, 2007 saw the fastest credit growth in the 30 year history of this data series.

No detailed breakdown of this is available, but there is little doubt that lending against shares has been a big part of this, perhaps the biggest.

Corporate balance sheets remain relatively conservative, but as we are now discovering through the problems of stockbroker Tricom, things are anything but conservative in the world of share trading.

Last year in particular saw a frenzy of leveraged share trading through a variety of gearing methods actively promoted by banks and brokers. Even super funds can be geared now using warrants.

And part of the reason there has been such a big rise in margin lending on stocks is that banks pay stockbrokers trailing commissions to sell the loans – just as mortgage brokers get trailing commissions to sell home mortgages.

Tricom has been one of the most active marketers of margin loans, but it is far from alone. Most brokers now have a very nice income on the side from margin loan trailing commissions, as well as commissions on stock lending and contracts for difference (CFDs).

The commission-driven boom in stockmarket leverage has been directly responsible for the largest rise in business lending in memory, and has combined with last year’s political profligacy to prompt the RBA to make a very dangerous interest rate increase tomorrow.

It’s dangerous because both of its causes are now being unwound: margin lending is in retreat as stocks enter a bear market of indeterminate length, and the Rudd Government is offsetting the tax cuts, and then some.

Meanwhile the US is entering, or is already in, recession, global growth is slowing sharply, and the Chinese economy is set deflate after this year’s Olympics.

Peter Fray

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