Well, they said it couldn’t last. And they were right! 

I’ve had a near perfect run of predictions for about two years – including predicting the first rise in this cycle against the market expectation. So I’ve been feeling smug about myself, but all good things have to come to an end. I think my run of luck is coming to an end, so I’m doing what I can to save my reputation and changing the prediction.

Until the Reserve Bank released its recent Statement on Monetary Policy I was predicting no change for interest rates in the next few months. To the surprise of the markets and lots of the commentators I respect most, the Reserve Bank has changed its tune on rates. Having said as recently as December that there was "no pressing need" for interest rate rises, the Bank is now suggesting that it has been debating rate rises internally, that so far it has desisted “on balance”, but that rate rises are likely in future.

I was approached by the Courier Mail to write a comment piece about this which you can read by clicking here – it's also replicated below the line. As you will see, I have changed my tune. My excuse for changing my mind? Well I’ve got a few. I could quote Lord Keynes the greatest economist of the last century. “When someone persuades me I am wrong, I change my mind. What do you do?” So I’m getting on board the vehicle chosen by most to effect rapid 180 degree changes in direction – the bandwagon.

Largely because of the Bank’s change of heart, I think rates are on the way up. There. I said it. It wasn’t so hard after all.

Is the Bank right to raise rates? Well, one of the things I always say which rather surprises media people who ask me to comment, is that in the event of a disagreement between me and the Reserve Bank on interest rates, I’ll back the Reserve. That is, while I’m still not convinced that the Bank is right, the fact that the Reserve has changed its mind is strong evidence that doing what it now proposes has gone from being the wrong thing to do to being the right thing to do. 

Of course they’ve got about 200 more people working on the issue than me. But there are plenty of organisations whose opinions I wouldn’t be quite so supine about. But I think the Bank is a class act. It's full of people who know what they’re doing (at least as well as anyone who looks into a crystal ball can know what they’re doing). And I trust the guy in charge – Ian Macfarlane. I think he’s got good judgement. .

I’d still offer the following warning. 

President Theodore Roosevelt practiced a brand of diplomacy he summarised as speaking softly but carrying a big stick. The Bank is doing the converse. It's speaking loudly so it can use a small stick – or the smallest stick it thinks it can get away with. 

The Bank will raise rates as little as it thinks is necessary because it will be acutely aware of the problem higher rates (and the resulting higher exchange rate) pose for exporters who we desperately need to thrive right now. In the past, the Bank has ‘jawboned’ as much as it could to restrain the economy – and usually the market commentators do a good job of ‘overshooting’ the likely tightening course they’re on. They leave people with the impression that rates could go up and up and up.

So it's possible that the Bank will surprise the markets once more and leave rates on hold next month. If it did, its tough comments might be seen as more ‘jawboning’ and telegraphing to the markets that it has moved from effective neutrality on rates to a ‘tightening bias’ rather than a firm decision to lift rates. 

I think this is unlikely as the strength of its recent comments – or how it's permitted them to play (and it has a hand in that in ‘backgrounding’ journalists) – will make it look silly. It's looking even more unlikely given that, since the RBA’s statement, further data on employment growth and housing finance suggest that the Bank is right – that things are hotting up.

But whereas the ‘no rises’ scenario seems unlikely, I don’t agree with the rest of the markets that there will necessarily be several rate rises. Chief Economist of the ANZ Saul Eslake puts it this way. “Moreover, since interest rate changes are (as the Americans say) like cockroaches - there’s never just one of them - we will be forecasting two rate rises over the next two months; although in reality this could be two over three months”.

He might be right and it's certainly the way the market is thinking. It's probably the way the Bank is thinking. But remember that the last time rates were raised by just 0.25% they had an immediate and larger effect that people were expecting – and in just the area they were hoping for, the housing markets. It's hardly surprising given the level of household debt. I think something similar will happen again this time and that, when it does, it will give the Bank time to wait for the next move. 

There’s a lot of uncertainty about where the economy is headed right now, and if the Bank waits after its first increase – which is quite likely – the initial rate rise and other forces will have some more time to unfold. A second rise may not be necessary.

Against all this, what can you do to protect yourself. 

Should you fix

Surprisingly in the face of expectations of rising rates, fixed rates are still very reasonable, with a major lender announcing a three year fixed rate special of 6.49%. Locking in for three years at basic variable rates should be pretty enticing for the risk averse. Indeed, given the unlikelihood of rates falling much below where they are now there doesn’t seem much risk of you paying much of a premium for the privilege of lower risk for the next three years. 

Remember fixed rates used to come with all sorts of restrictions on your ability to make additional repayments and redraws, but against the bracing winds of competition some lenders are breaking ranks. One lender now even allows you an offset account on your fixed rate loan which gives you all the flexibility you could want. So call us if you’d like to lock in. The bond market should have already priced in the likelihood of a rate rise, but there’s often a bit of a lag in the fixed rate loan market. If and when variable rates rise, fixed rates may rise with them.

Can you get your lender to pay?

Remember that lenders’ margins are still falling. Call us if you want a ‘mortgage checkup’ to see if we can pass some of the next 0.25% rise in rates onto your lender – or another lender with a refinance!

Paying for promises

The Reserve Bank caused mortgage-holders to draw breath this week by setting out a case for an imminent interest rate rise. Nicholas Gruen looks at the issues.

Published in The Courier Mail, 9th February 2005.

At least Labor voters can't complain. John Howard said that if you voted Labor you'd get a government that couldn't take the tough decisions and you'd get higher interest rates.

Well, you voted Labor. And now it's all coming true. You kept your part of the bargain and so did he.

We've just had an election campaign in which policies were a kind of shadow play for the real content of the campaign which, like other recent campaigns, went on deep in our psyches.

Remember, this was a campaign which was won by the party that made us think about responsible economic management and the importance of keeping interest rates low while doling out billions of dollars at each whistle stop of the campaign.

As recently as December our Reserve Bank saw "no pressing need" for interest rate rises. But now it's suggesting that it has been debating rate rises internally, that so far it has desisted "on balance" but that rate rises are likely in future.

In its latest quarterly statement on monetary policy, the Reserve says that the party we've been having for the past 14 years is starting to look fragile. For many years now the economy has been crying out for more investment on research and development workforce skills and on infrastructure (something on which you can reflect as you wait in the traffic jams from the Sunshine to the Gold Coast).

Now those shortfalls are beginning to bite, reducing our productive capacity and so putting pressure on inflation and on our (already woeful) export performance.

Our election wasn't about how to check these trends, it was about the cheque in the mail, whether it was $100 for pensioners, $200 for self-funded retirees, $600 for families or $800 for apprentices. (That last bit was for a tool kit would you believe? A skills policy with all the sophistication of the episode of Bob the Builder from whence one imagines it came).

While all this was going on six economists, including yours truly, drew attention to some of these problems.

We pointed out that Australia's share of world export markets had fallen below 1 per cent for the first time since the advent of steam ships, that we were spending about 6 per cent of GDP or $50 billion more on payments for imported goods and services, and interest and dividend payments than we were receiving from foreigners in return. (The Reserve Bank now suggests the current account is rising towards 7 per cent).

The six economists tried all the tricks. We arranged our suggested policy agenda under headings that allowed the unalloyed allure of alliteration. We called for policies to promote Prudence, Participation and Productivity.

The statement made quite a splash being published, quite fortuitously, on the morning of the debate between Treasurer Peter Costello and Shadow Treasurer Simon Crean. But neither man mentioned it. When finally prompted by media questioning, both returned to their more familiar bickering about tax winners and losers.

Both men had good reasons for not dwelling on the potential weaknesses of our economy. Acknowledging them obviously would take the gloss of the Government's subliminal election campaign associating continuing strong growth with good economic management.

And both were bidders in an auction of giveaways. Larger surpluses and/or a greater proportion of outlays on investment rather than goodies for the electorate would have cramped their style.

Both parties were playing "you show me yours and I'll show you mine". Each wanted to steal the other's thunder, and both were manoeuvring for the title of most fiscally responsible (by being least fiscally irresponsible).

This acquires an additional degree of difficulty when one is looking in the rear vision mirror trying to spot how much cash your political opponent has littered in his wake.

Now we'll pay the price in higher mortgage payments. The good news is that rate rises probably will be quite modest – half or even a quarter of a per cent may be all that is needed. But there's a sting in the tail.

We do need to take our medicine, but the medicine the Reserve Bank is being forced to use comes with nasty side effects. Higher interest rates have their effects by depressing the economy. Right now our economy seems to be slowing but we're not managing the transition from consumption to production and export.

Higher rates will depress consumption, but they'll also depress production, and they'll particularly depress production for export because they increase the exchange rate.

They slow the party down just like we want, but they make it harder to redirect our energies to where they should most go – into research, increased skills, infrastructure investment and export.

So we're guaranteed pain, but not the gain that might have come from other measures.

Higher surpluses (or failing that tax cuts or other goodies paid to us as superannuation contributions) and government investment in keeping the economic miracle going – infrastructure, skill development, research and development incentives.

What a pity our politicians didn't show a little more leadership – oh and, of course, we didn't show a little less credulity.

Dr Nicholas Gruen is a visiting fellow at Australian National University and Melbourne University and CEO of Lateral Economics and Peach Discount Mortgage Broking.

Until next month,

Nicholas Gruen
(AKA Dr Peach)

March 2005

The observations made here are general and indicative. They are not warranted as free from error in any respect whatsoever. We are not financial or tax advisers and you should not rely on any aspect of these comments without taking independent financial advice relating to your own specific circumstances. We suggest you obtain advice on a fee for service basis rather than from someone who earns commissions from investments they recommend.