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That sinking feeling

What was the Reserve Bank Governor, Glenn Stevens, thinking of when he and his board supported another interest rate rise, taking the official cash rate of interest to 7%? It’s not about killing home owners locked into a too-big loan. But it is about killing something called inflation.
The heavy price
Like with most battles, there is often what the military calls human collateral! Anyone who loses his or her home because of this war on inflation needs a lot of consolation, as most economists and commentators, including yours truly, did not think we’d get to this.
The big losers
There is a perfect storm of a strong China and India pumping demand into our resource sector. This boosted profits and taxes to the Federal Government and they gave a lot of it back in the form of five tranches of tax cuts. The latter ones were targeted to improve the Howard Government’s political standing. The policy turned out to be a failure on two fronts – they lost the election and we’re now copping higher interest rates. A surprising point should be at this stage – 43% of Aussies are not in debt!
It’s the economy, stupid
Those who made the decision to raise justified it on economic terms. Have a look at this lot.Oil spurting to $US100 barrel a few months ago hasn’t helped, nor did the Oz dollar not making parity. The costs of agricultural products, such as wheat, has also headed in the wrong direction and now economists are talking about a new concept – ‘agflation’
.It’s the good economy, stupid
We also have unemployment around recent historic low levels of 4%. Private sector borrowing boomed at the fastest pace in 19 years, up 16.5% in December compared to a year ago. Business rose 1.6% to an annual rate of 24.3%  – the fastest growth in 19 years
When Comm Sec’s head economist, Craig James, saw these numbers he knew a Reserve Bank rate rise was certainty.
“Lending figures continue to point towards business borrowing driving the economy,” he wrote in his daily newsletter. “Businesses credit has been behind the wheel of the economy for some time. Business borrowing continues to grow at the fastest rate in 19 years. And with additional investment in production capacity being made, the outlook for the local economy remains strong.” But that wasn’t all.
And there’s more …
The NAB business survey showed a very solid and improving economy with the index of retail margins rising to plus 15 points in December – the highest reading in more than six years. This was a flashing red light that inflation was being fuelled by retailers.
On top of that we saw the likes of Melbourne see house prices spike to the tune of 25% in 2007. Brisbane was up 20.1%, Adelaide 20% and Canberra 14.6%. Sydney's median house price went up only 4.8%, but it remained the most expensive in the country at $553,357. The country’s past-fastest riser Perth only went up 1.7%.
On the downside
On the other side of the economic equation – the stock market fall – the poor state of home building, rising indebtedness and home repossessions, along with the slug from high petrol prices says it’s not all boom, boom caboom in the Aussie economy.
On top of that there have been 11 official interest rate rises – along with some unofficial ones from the banks because of the sub-prime and credit crunch – and the negatives start piling up.
Warning: stop spending!
Throw in the fact that a determined Reserve Bank boss gave warnings that suggest there could be more on the way and I reckon we’re in for a slow down. And that’s what the Big Bank wants.
The last rise?
Someone like Craig James thinks the latest rise will be the last, but he is in a slim minority on this one.
I believe Stevens is using tough talk to spook many hopeless spenders to pull their purse strings in. He knows he is flirting with danger by raising interest rates for the minority of homeowners who are in debt stress. And so the promise of more rises might mean he will be able to break his promise.
Of course, if the US recession becomes a reality the stock market will head south, taking income and confidence. That could end this cycle of increases and would lead to unemployment.
We don’t need to be choked
As someone who cannot forget the old historical observation that central banks nearly always over-tighten, leaving their fingerprints on an avoidable recession, I hope the Big Bank doesn’t overplay its interest rate card.
Promises, promises
Our new Prime Minister could also think about welching on his tax cut election promises - that will test his leadership skills. These were made by a government desperate to hang onto power and they had to be matched for political purposes.

History has shown that good economics is bad politics, but that’s what we need – a good dose of bad politics. 

Published on: Wednesday, February 06, 2008

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