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Can we expect monetary and fiscal policy to work together?
The Reserve Bank of Australia (RBA) met this week and, as expected almost unanimously by economists, kept rates on hold at 4.35%. In the post meeting press conference, Michele Bullock revealed that, while the Board maintained its neutral bias, they considered raising rates following the upward surprise to March quarter inflation, before ultimately deciding not to.
Ms Bullock reiterated that the Board believes rates are where they should be to bring demand back in line with the supply in the economy, and importantly, that inflation expectations in financial markets remain well anchored. Any evidence of rising inflation expectations would likely be seen by the Board as a red flag that they may need to take out another insurance hike, as they did in November last year.
The RBA also released their latest Statement on Monetary Policy (SOMP), which contains all their forecasts for the economy. The upward surprise in the March quarter CPI of around 20bps was expected to lead to an upward revision to the RBA’s end of year forecasts. But the SOMP revealed the RBA’s forecasts for inflation by the end of this year were revised up by a whopping 60bps for headline, and 30bps for core.
Interestingly, their forecasts now see core inflation at 3.4% by the end of this year, which is in line with QIC’s forecast. The upward revision to the headline inflation measure, at 3.8% by the end of the year, is half a percentage point higher than QIC forecasts. While the recent rise in petrol prices has pushed the RBA’s headline inflation forecasts higher, the forecasts do not include the extension of electricity rebates recently announced by the Queensland and WA state governments, which will likely lower the RBA’s near-term inflation forecasts. Next week will see the 2024/25 Federal Budget released, with the prospect of more cost-of-living subsidies to be revealed.
While the Mid-Year Economic and Fiscal Outlook (MYEFO) forecast a small deficit for 2023/24, the Budget is likely to show a second consecutive year of being in surplus. This will be the first time since 2007/08 that this has been the case. Unfortunately, the run of surpluses is likely to come to an end in 2024/25, where we expect a deficit of around $10b as the revamped Stage 3 tax cuts reduce government revenues.
In recent months, Treasurer Jim Chalmers had been shifting the narrative away from the cost-of-living pressures and towards the weakness in growth in preparation for an expansionary budget. But the strong March quarter CPI, the sharp shift in market pricing towards rate hikes instead of rate cuts, and now the inflation upgrades from the RBA, has combined to shift the focus of this budget squarely back on cost-of-living pressures in the short term.
The main initiative in the Budget, though not new, will be the Stage 3 tax cuts to be implemented from July. The tax cuts apply to all incomes above the tax-free threshold of $18k, and are worth around $2000 a year for incomes of $100k, and up to $4500 a year for incomes around $200k. But the tax cuts will be delivered gradually via higher take-home pay rather than as a lump sum, meaning households won’t feel immediately more wealthy.
It is likely the Budget will include an extension of last year's cost-of-living assistance in terms of electricity rebates, rent assistance and pharmaceuticals, all targeted towards low-income households. There has already been an announcement of targeted support for some students – those studying teaching, nursing and social work – who will receive payment while undertaking their mandatory placements. Students of other disciplines would feel left out, which may explain the reduction in higher education HECS debt which will be backdated. While this won't really help with students' cost of living now, it may make them feel a little less burdened by the rising value of their debt.
After significantly boosting the wages of aged-care workers last year, it is likely that this year’s Budget will make similar adjustments to the wages of childcare workers. Like aged care, the childcare sector is also overly represented by women, part of the care economy that is low-paid, and is an industry struggling to attract and keep workers.
In recent years, the government has worked hard to establish its economic credentials by saving a large proportion of the windfall gains earned from better-than-expected economic outcomes, rather than spending them. This year’s Budget is likely to follow a similar pattern, so we are not expecting a lot of new spending initiatives this year. There's a few of reasons for this.
The first is that the government won't have as much money to splash around given the more modest windfall gains they will be banking this year, compared to previous years. We expect they will only have around a quarter of the windfall they earned this time last year. Secondly, the government is under pressure to maintain a contractionary fiscal stance in the near term to support the RBA's efforts to reign in demand. And finally, there's an election due this time next year. The government would no doubt prefer to have an RBA rate cut or two under their belts going into the election, so the less spending they do in the near term, the greater the odds of achieving that.