It seems the markets have joined the chorus of calls for the Reserve Bank to lift rates for the second time this year at next Tuesday’s meeting. Not everyone, however, is singing that same old tune. As the Oz reports, Treasurer Peter Costello weighed in immediately, saying “Interest rate policy has to take into account that you will have one-off effects like cyclones – it’s not directed at undoing the effect of a cyclone.”

While it is true that the RBA tends to factor in such cost-driven inflation caused by banana shortages and skyrocketing petrol prices, it does become concerned when businesses pass on their increased costs to consumers. The evidence that this has occurred came in the form of the RBA underlying inflation rate, which disregards the extreme price rises, calculated to be 0.9% for the second quarter, and an uncomfortable 3% for the year. Monday’s PPI rate of 4.5% is further evidence.

Ongoing geopolitical tension, a euphemism for Middle Eastern war, will make sure petrol prices do not recede too far from their current peak. Businesses will be forced to pass on the higher costs across the board, and Australia’s reputation for price stability is at risk of being lost. On top of this is the mother of all resource booms increasing prices for crucial Australian goods.

Peter Costello is well aware of what is at risk for the Howard Government; it has staked its economic credibility on low interest rates, and has basked in the glory of the 30-year low unemployment rate and consistently strong economic growth. Now, rising interest rates, with their inevitable impact of slowing the economy, will bring the Government’s economic credentials into question and alter people’s voting preference.

Everyone and their dog knows unutilised labour capacity is nowhere near as low as 4.9%, a fact that would support Peter Costello’s argument were he able to admit it. As it stands, a slowing economy will push up unemployment, which will have a dramatic impact. The worst case scenario for the Government in the run-up to next year’s Federal election would be a deceleration in economic growth coupled with rising inflation, interest rates and unemployment. Undoubtedly, the RBA’s aim would be to rein in inflation without impacting too heavily upon growth and employment – it remains to be seen whether this is possible.

Read more at Henry Thornton.