One Cluck Cocks The Trigger

by Peter Hartcher - Sydney Morning Herald

It was just a tiny click, but it reverberated like a thunderclap. When Rory Robertson hit the "send" button on his email at 6.08 on Wednesday evening, he awakened the financial markets to a danger they'd forgotten.

"This is a big change of tune for me," began his newsletter to investors and traders. "But - after a long period of inactivity - the tide looks to be turning on the local interest rate front."

Interest rates, wrote the Macquarie Bank specialist on the subject, were poised to go up, and the Reserve Bank's next rate increase "could be as little as a month away".

Immediately, the markets moved to anticipate a rate rise. The Australian dollar jumped by about one cent against the US currency as traders anticipated that higher interest rates would attract an inflow of foreign money in search of higher yields.

The market that most directly speculates on the course of interest rates, the market in bond futures, was last night priced to expect with confidence that there will be at least one rate rise this year, and was hinting at the possibility of a second by December.

Robertson's competitors in the Deutsche Bank trading room were so grateful for the moneymaking opportunity of such a wild market move they headlined their daily client report "Rory! Rory! Rory!", and nominated him for "the Chicken Slapper Hall of Fame".

A chicken slapper, it turns out, is their affectionate term for the seers and entrail readers of the modern world - the economic forecasters.

"That's the nice thing about having a lot of readers in the market - everyone gets the same thought at the same time," says Robertson. And the market moves accordingly. "The market went from expecting nothing a week ago to today being certain of a rate rise by May."

It was the most significant political event of this week, and it did not even happen in politics, as conventionally defined.

The broad picture is that after 15 years of continuous economic growth, the Australian economy is running out of spare room. As it approaches capacity, the risk of excess inflation rises. And the Reserve Bank is pledged to prevent that. When Peter Costello yesterday convened the media to bask in the good news that unemployment had fallen from 5.3 per cent to 5 per cent, he was inadvertently advertising that fact.

When a reporter asked him whether the low unemployment rate presaged a rise in interest rates, the Treasurer answered: "Let's not start getting worried about low unemployment. We have been trying in this country to get here for 30 years so let's not start getting worried now that we are there." But that's exactly what the Reserve Bank's governor, Ian Macfarlane, is paid to worry about.

Any rise in interest rates is politically potent for three reasons.

First, John Howard was re-elected on his pledge to keep interest rates low. Sound economic management is his core competency. The Reserve Bank raised rates once last year. To raise rates again this year once, and perhaps even twice, would strike at his central political strength.

The central bank adjusts interest rates in increments of one quarter of a percentage point at a time, so a single rise would not be catastrophic for the household balance sheet. For the average new mortgage of $220,000, the annual mortgage repayment would go up by about $550. This may not be a vast sum, but it would be as real as the $600 family payment that became an issue in the last election.

And any increase would be the second rise in this term of the Howard Government, taking the cumulative increase in average repayments to $1000 a year. A second rate rise this year would take the increase in the cumulative repayment burden of Howard's fourth term to more than $1500. And it would give Labor something very specific to attack with.

John Stirton, from the pollster ACNielsen, says: "People are feeling good about the economy. It is John Howard's biggest strength and it's why governments around the country are being re-elected. If people start to lose that confidence, it will have a big effect because it's John Howard's strongest suit."

Second, rising interest rates would be a force multiplier for the political potency of Labor's campaign against the workplace changes. The Government's industrial relations changes are designed to have a gradual impact. The new legislation will not have its full impact until there is a slowdown in the economy. The new system is designed to allow market forces fuller play in negotiations between worker and boss.

The specific purpose of raising interest rates would be to slow the economy. The slower the economy, the greater the shift in bargaining power from the worker to the boss. So any slowing in the pace of economic growth over the year and a half to the next election will magnify the tangible effect of the workplace relations changes. It will have a doubling-up effect. It makes the workplace legislation gamble much riskier for Howard.

Third, if Ian Macfarlane is sitting on the edge of his seat, ready to push the big red button marked "interest rates", this will limit the scope for the Federal Government to hand out tax cuts in the May budget. The Government cannot be seen to be economically irresponsible, delivering tax cuts that could contribute to the overheating the central bank is anxiously trying to avoid. There is no point doling out money to voters in the form of tax cuts if the Reserve Bank takes it away again in the form of higher mortgage payments.

The chicken slapper's note went out with a click and set off a thunderclap; the shift in interest rate expectations may have sounded like only a dim rumble, but it could presage a tectonic shift.