Stand-off as PM warns on rate rises

4 March 2005

The Prime Minister, John Howard, fired a warning shot at the Reserve Bank on future interest rate rises yesterday, as the bank prepared borrowers for back-to-back rises.

The bank shrugged off news that economic activity stalled in the second half of last year to make the case for a further lift in standard mortgage rates to about 7.6 per cent, probably next month. Most banks lifted their home loan rates to 7.32 per cent yesterday.

A speech by the bank's assistant governor, Malcolm Edey, showed its views were unchanged by Wednesday's low growth figures.

Mr Edey said the figures concealed unusually strong levels of domestic demand. The inability of producers to meet this spending would feed "a gradual increase in underlying inflation from here on", he said.

The comments were interpreted to mean the bank would press on with rate increases, with the next likely to be delivered early next month.

But Mr Howard said there were good arguments against the Reserve Bank increasing interest rates again.

"Inflation is low, there is no sign that wages are breaking out ... and there are signs that growth ... in the economy has moderated," he told 2GB.

"If you put all those things together, there is a respectable argument that there should not be another [rate] rise for a while."

While saying he was not criticising the bank's move, Mr Howard said: "I would have preferred, obviously, to see interest rates stay where they were."

The Treasurer, Peter Costello, also played down the prospect of a further rate increase, saying Australians should not necessarily expect another rise in the near future.

Mr Howard and Mr Costello must grapple with the unusual prospect of higher interest rates and lower growth than almost any comparable country, and a sustained period of uncertainty.

"I don't know what the hell is going on," one government economist conceded yesterday.

Mr Howard yesterday also defended his election promise to keep rates low.

"What I did say, and I don't apologise for this, is that we will keep interest rates lower than would Labor," he said.

"Interest rates are still low - in recent experience, very low still."

The Opposition Leader, Kim Beazley, said the Government bore responsibility for rate rises because of reckless election-year spending and failures to improve infrastructure or tackle reform.

"Costello and Howard are in this rate rise up to their armpits and it's a direct product of what they did to get themselves reelected last year," he said.

Economists said the growing gap between spending and production could close if demand slowed, perhaps causing recession. The better option would be to increase investment in transport, expand the labour force through education and training, and encourage people off welfare.

Pressure is mounting on the Government to tackle hard reforms. "We've been incredibly lucky over the last 10 years," said Dr Mardi Dungey, an economist at the Australian National University. "We've been living off the fat of the last reforms. Something has to give."

Mr Costello said the economy was now "rebalancing" from spending to exporting.

But this week's national accounts present scant evidence that this rebalancing has begun.

Mr Edey said the process would take considerable time.

He pointed instead to the "remarkable" flatness of exports over four years despite three years of above-average strength in the global economy.

"Domestic demand, on the other hand, grew by 4 per cent over the year, and continued at that rate in the December quarter," he said. "What the figures indicate is demand is being met not by commensurate growth in production, but to a large extent by growth in imports and by a rundown in inventories."

Addressing the Business Council of Australia's annual strategy forum at Yuroke, north of Melbourne, Mr Howard reiterated that industrial relations reform was at the top of his agenda, but said a minimum wage should always be preserved.

"We are examining the way the minimum wage is set, but I have to say to you that I think it would be out of step with the Australian ethos to not have a minimum wage," he said.