First, apologies to readers. After having successfully dodged COVID until now, my luck finally ran out a bit more than a week ago. That meant missing both last week’s RBA meeting and this week’s Budget lockup. It also meant postponing this week’s Budget webinar until Thursday May 18. Register here for the Budget webinar. Again, sorry to everyone for any inconvenience and I hope the new timing works for you.
We have an abbreviated note this week. I will provide a brief discussion of the macroeconomics of Budget 2023-24, review last week’s RBA meeting and the forecast revisions in the May 2023 Statement on Monetary Policy, and recap some key data releases. But a deeper dive into fiscal and monetary policy will have to wait until next week’s rescheduled webinar.
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Budget 2023-24: A (temporary) return to surplus
Assuming nothing derails Budget outcomes over the next few months, Australia is on track to record its first federal government Budget surplus in 15 years. On Budget night, Treasurer Jim Chalmers said he expected a modest underlying cash surplus of about $4.2 billion (0.2 per cent of GDP) in 2022-23, before the Budget slips back into a small deficit of $13.9 billion (0.5 per cent of GDP) in 2023-24.
The new path for the deficit over the forward estimates as set out in Budget 2023-24 now anticipates a cumulative deficit of almost $110 billion in the years to 2026-27. And while that does confirm that Australia’s structural Budget deficit challenge has not been abolished, the new deficit trajectory is nevertheless significantly lower than the one foreseen at the time of the October 2022 Budget, with a cumulative improvement in the underlying cash balance of $125.9 billion over the next five years. One consequence of that sequence of smaller deficits is a marked improvement in the public debt position, with the ratio of net government debt to GDP now forecast to peak both sooner and lower (by several percentage points of GDP) than was anticipated last October.
For more on the fiscal numbers, please see my initial Budget assessment here.
The macroeconomic context for this year’s Budget was provided by inflation running far above target and a central bank that had recently reminded everyone that it remained ready to further tighten monetary policy to bring inflation back to target (see next story). The message to Canberra from the 2 May RBA Board meeting was that any fiscal splurge would only serve to trigger an offsetting increase in interest rates from Martin Place.
At the same time, however, the political and social context for the Budget was pushing fiscal policy in the opposite direction, with voters in general and some of the most vulnerable segments of the population in particular suffering a severe cost of living squeeze and expecting fiscal support.
The challenge facing the Treasurer on Budget night, then, was to balance these two competing imperatives. Of course, by opting for any kind of middle path, the Budget would then be vulnerable to criticism from both perspectives.
Start with the macro. As well as the politically powerful signal of delivering the first (albeit one-off) Budget surplus in a decade and a half, the Treasurer has significantly pared back the scale of expected deficits across the five years of the forward estimates. Those outcomes were supported by the decision not to extend either the low and middle income tax offset (LMITO) or the cut in fuel excise tax. But they were mostly underpinned by the choice to ‘bank’ much of a series of windfall gains arising from higher than anticipated tax receipts and other helpful ‘parameter variations’ out to 2026-27.
One consequence of this relative fiscal restraint is that, after expanding by 6.5 per cent in 2021-22, the rate of growth in public final demand is expected to have slowed to 1.75 per cent in 2022-23 and is now projected to slow again to 1.5 per cent in 2023-24. According to the Budget Papers, in real terms, growth in payments is expected to average just 0.6 per cent a year over the five years of the forward estimates, compared to average annual growth of around 2.2 per cent over the pre-pandemic (2011-12 to 2018-19) period.
Given the circumstances, that represents a decent degree of fiscal prudence, and as such, this Budget seems unlikely to scare the RBA in terms of its implications for inflation. Of course, the Treasurer could have gone further and done more to actively help the central bank: instead of modest net new spending, there could have been none, with the government banking all the revenue gains and offsetting any new spending with cuts elsewhere. Or policy could have even actively aimed to pull additional demand out of the economy. Some hard-headed economists will no doubt complain that even the modest injection of spending delivered this week will unduly complicate the RBA’s fight against inflation. But the government could respond that it also has a duty to provide at least some protection to the most vulnerable in that fight.
To that end, Budget 2023-24 does offer some constrained generosity to those most in need in the form of energy subsidies, increased welfare payments and other assistance. Of course, a different set of critics will charge that the government hasn’t been anywhere near generous enough, given the scale of current pressures. But here the Treasurer can reference his first set of critics and point to the risk of triggering more rate increases from Martin Place.
Overall, when considered in terms of the required balancing act, the place where Budget 2023-24 ended up looks quite reasonable.
Last week’s RBA rate hike and the May 2023 Statement on Monetary Policy
At its meeting on 2 May 2023, the RBA Board decided to increase the cash rate target by 25bp to 3.85 per cent. The week before that meeting I’d written that I expected the decision to be very close, but that on balance I anticipated no change. That turned out to be wrong, so what did I miss?
Reading the accompanying statement, the RBA noted that although:
‘…the recent data showed a welcome decline in inflation, the central forecast remains that it takes a couple of years before inflation returns to the top of the target range…Goods price inflation is clearly slowing due to a better balance of supply and demand following the resolution of the pandemic disruptions. But services price inflation is still very high and broadly based and the experience overseas points to upside risks. Unit labour costs are also rising briskly, with productivity growth remaining subdued.’
That suggests that part of the story was the RBA putting a bit more weight on the strength of services inflation and a bit less on the softer goods result and the decline in the overall headline and underlying inflation rates than was implied in my calculations.
Another important consideration looks to have been the central bank’s concern that not only was inflation still well above target, but that its’ own forecasts were predicting only a gradual return to target.
‘Inflation in Australia has passed its peak, but at seven per cent is still too high and it will be some time yet before it is back in the target range. Given the importance of returning inflation to target within a reasonable timeframe, the Board judged that a further increase in interest rates was warranted today.’
In addition, given that I did caution ahead of the May meeting that ‘a 25bp hike next week would not be particularly surprising’ even after tipping a pause as the more likely outcome, the RBA’s decision to hike shouldn’t be seen as the big surprise implied by disappointed financial market expectations.
This May’s 25bp hike to the cash rate means that in the year since the RBA began to tighten policy on 4 May 2022 the central bank has delivered a cumulative 375bp of rate hikes over a very aggressive policy cycle. So, are we about done? Barring any further inflationary shocks, we do seem likely to be either at or close to the terminal rate, although there is still scope for one more hike in the coming months. Hence the RBA noted:
‘Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve.’
- The near-term outlook for inflation has been adjusted down. Back in February, the RBA thought the headline rate of CPI inflation would be 6.75 per cent in the June quarter of this year and 4.75 per cent in the December quarter. It now thinks those rates will be 6.25 and 4.5 per cent, respectively. Importantly, however, it has left its forecasts unchanged further out, and still thinks that inflation will only return to the top of the target band by the June quarter 2025. It is a similar story for underlying inflation as measured by the trimmed mean, which is now predicted to be a quarter of a percentage point lower in the June and December quarters of this year, but with no changes to the forecast further out. Trimmed mean inflation is still expected to fall to three per cent by the December quarter of 2024.
- The RBA now expects real GDP growth to be slightly weaker in the near term than it did at the time of the February 2023 SMP. Year-ended growth in Q4:2023 has been lowered from 1.5 per cent to 1.25 per cent and year-average growth for 2023 has been cut from 2.25 per cent to 1.75 per cent. But further out the growth forecast has been adjusted modestly upwards.
- Alongside slower economic growth, the forecast unemployment rate has been nudged up for Q4:2023, from 3.75 per cent to four per cent. By Q4:2024, the unemployment is now forecast to be 4.5 per cent instead of the 4.25 per cent predicted in February’s SMP. Along with a slightly looser labour market, the RBA has also trimmed its forecasts for wage growth as measured by the WPI.
Note also that a new RBA chart pack is now available with data updated to 27 April 2023.
Other points to note on the Australian data front
The ABS said retail sales volumes fell 0.6 per cent over the quarter in Q1:2023 and were up just 0.3 per cent compared to the same quarter last year. Retail sales volumes have now fallen for two consecutive quarters (they dropped 0.3 per cent over the December quarter) as household spending continues to be squeezed by the higher cost of living. Retail prices rose for the sixth quarter running but the ABS noted here that the rate of growth of prices in the March 2023 quarter was the slowest since the September quarter of 2021, reflecting discounts on clothing and large household items such as furniture and electronic goods.
The ABS Monthly Household Spending Indicator rose 8.2 per cent through the year in March 2023 (current price, calendar adjusted basis). The Bureau said the rate of growth eased across all spending categories, with spending on discretionary goods and services rising at 2.2 per cent, down from a peak of 28.3 per cent in August last year. Spending on non-discretionary goods and services has also slowed, albeit to a lesser extent, easing to 13.9 per cent in March from an August 2022 peak of 29.9 per cent.
The ABS Monthly Business Turnover Indicator rose over the month in 11 of the 13 published industries in March 2023 and was higher in annual terms across all 13.
The NAB Monthly Business Survey for April 2023 showed the index of Business Conditions softening by two points to an index reading of +14 index points (still above the series’ long run average). The Business Confidence Index rose by one index point to a neutral reading of zero index points (which is below the series average). Labour cost growth was unchanged last month at 1.9 per cent in quarterly terms, purchase cost growth rose to 2.3 per cent from 1.9 per cent in March, overall final product price growth fell to 1.1 per cent from 1.3 per cent, and retail price inflation eased to 1.4 per cent from 1.7 per cent.
Last week, CoreLogic said its national Home Value Index (HVI) rose by 0.5 per cent over April 2023 to be up one per cent over the quarter, albeit still down eight per cent over the year. This was the second consecutive monthly rise, after the national HVI rose by 0.6 per cent in March 2023, and according to CoreLogic, suggests that ‘Australian housing values look to have bottomed out.’ The Combined Capitals index rose 0.7 per cent over the month and 1.4 per cent over the quarter but was still down 8.4 per cent in annual terms. By capital city, monthly price gains were largest in Sydney (up 1.3 per cent), Perth (up 0.6 per cent) and Brisbane (up 0.3 per cent). Only Darwin (down 1.2 per cent over the month) suffered a decline. The data provider also pointed to auction clearing rates running slightly above their long-term average, a lift in sentiment, and housing sales trending around the five-year average as together indicating an inflection point for the Australian housing market. After having risen 26.2 per cent from the onset of COVID to their recent peak in April 2022, dwelling values then fell 9.1 per cent to their latest trough before rising by 1.2 per cent. CoreLogic also reported that Australia’s capital cities recorded their strongest annual rental increase in history in April 2023, with the combined capitals annual rental index rising 11.7 per cent over the past year.
Also released last week, ANZ-Indeed Job Ads fell 0.3 per cent over the month in April 2023, after a downwardly revised 2.7 per cent decline the previous month. Ads are now 7.7 per cent lower than their September 2022 peak and at their lowest level since January 2022. Even so, they are still more than 52 per cent higher than their pre-pandemic levels.
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