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Economic and Financial Market Update: 2022 Budget - something for everyone

31 March 2022

Summary:

The Budget forecasts are reasonable, although conservative;
Despite the strong economy, the deficit is not projected to narrow much over the next year;
If the economy remains strong some fiscal tightening is likely to be required;
Independent of the Budget, I have changed my cash rate view;
I now expect the first rate hike in June, with the cash rate to be 0.75-1% by year-end.

On face value this Budget had it all. There was something for the economists (smaller budget deficit, a downgrade to the debt profile). There was also something for those who work in the ‘real’ economy (fiscal support for those facing cost of living pressures). And there was also something that can be placed in the bucket of ‘boosting productivity’ (infrastructure spending).

Hard-nosed economists would have preferred to see a smaller budget deficit at a time of rising inflation concerns. But that was always going to be a big ask in an election year. Governments should provide support to low-income earners at a time of major challenges to their household budgets.

But the next Budget (and it could be later this year) really should be less generous. The economy is currently not in need of extra support. Extra infrastructure projects right now will just bid up the price of materials and workers at a time when both are already getting costly.

The big picture is that Government (both federal and state) spending has become a bigger part of the economy. At the same time, our tax base is too narrow (over reliant upon income tax) and our total tax take too small to fund the extra spending. The result is ongoing budget deficits. At some stage soon we need to decide about whether we want governments to spend less or tax more.

The one proviso about smaller budget deficits is that the economy continues to perform strongly. An extremely low unemployment rate, strong business capex spending, backlog of orders in residential construction, a mountain of infrastructure work and strong export performance by our farmers and miners all provide confidence that it should.

But the global economy is being hit by a major negative supply shock (from COVID and the Russia-Ukraine War). And global interest rates could rise substantially on inflation concerns. This means there is a risk that economic growth does slow faster than expected. Maybe not next financial year (2022-23) but potentially the year after. If that does happen further fiscal support may again be required. Hopefully debt levels (compared with GDP) are lower the next time fiscal stimulus is required.

The Budget has few immediate implications for monetary policy. An economy with an inflation rate likely to be above 4% and an unemployment rate likely to be under 4% does not need a cash rate of 0.1%. I now loom for the first cash rate move to be in June, with a year-end target of 0.75-1%.