ECONOMIC INSIGHTS - EDITION 36: MAY 2016
A cash rate cut and a relatively neutral Federal Budget have improved the outlook for domestic spending and reduced the risk of the economy falling in to recession this year.
Touching The Policy Accelerator
Key point: A cash rate cut and a relatively neutral Federal Budget have improved the outlook for domestic spending and reduced the risk of the economy falling in to recession this year.
Australia’s unusual combined monetary and budgetary policy day on 3rd May ended with a more growth accommodating monetary policy setting plus a budget that is broadly neutral in what its initiatives will give and take from spending in the economy over the coming financial year.
Domestic spending may be stronger than expected
The net impact of the rate cut and the budget is that domestic spending should be a touch stronger over the next year or so than otherwise would have been the case.
It needs to be kept in mind, however, that ahead of the policy announcements on 3rd May, growth in domestic demand appeared set to lose momentum with housing activity and retail spending both set to lose some of the strength exhibited through much of 2015. That potential loss of growth momentum may be avoided by the combined policy moves, especially if the RBA follows up with another rate cut over coming months which we view as a reasonable chance in the wake of the recent rate decision.
The RBA has reacted to low inflation…
Taking the RBA cash rate decision first, the accompanying statement makes it plain that the key change in the economy driving the decision was evidence in the Q1 CPI report that inflation was running below the RBA’s expectations and is likely to stay lower for an extended period.
The RBA is still a committed inflation-targeting central bank and sees its best opportunity for maximizing sustainable economic growth as trying to generate longer-term inflation within its 2-3% annual target band. This was summed up neatly in the final lines of the statement, “the Board judged that prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting”.
…which may see a 2nd cash rate cut in August
We will see how far inflation is tracking below the RBA’s earlier forecasts when it publishes its latest economic forecasts in its quarterly Monetary Policy Statement on Friday 6th May, but on the basis of the downside surprise, close to half a percentage point below estimates in all measures of annual inflation, another 25 basis points (bps) cash rate cut to 1.50%, probably in early August after the Q2 CPI report likely confirms that annual inflation has pushed even lower to around 1% year-on-year.
The 25 bps cash rate cut to 1.75% announced by the RBA on 3rd May, especially with the almost immediate pass through to lending rates by most banks, will help to boost spending in interest rate-sensitive parts of the economy such as housing – more accurately elongate the topping out process in housing. Consumer sentiment may receive a boost too. The rate cut, coming as a surprise to the majority of financial market participants, has also cut in to the strength of the Australian dollar.
Some pre-election Federal budget views
Turning to the second set of policy announcements contained in the Federal Budget for 2016-17, the first point is that what the Treasurer took from some wealthier superannuants and smokers he gave back in almost equal measure to some others, small-to-medium sized businesses and personal income tax payers earning over $80,000 a year.
On Treasury’s forecasts, the underlying budget balance barely moves between an estimated -$39.9 billion, or -2.4% of GDP, in 2015-16 to -$37.1 billion, or -2.2% of GDP, in 2016-17. The impact of change in net federal government spending on total spending in the economy is virtually neutral in 2016-17 compared with 2015-16 and that is about as generous as a pre-election Treasurer could be with international credit rating agencies starting to worry aloud about Australia’s AAA sovereign credit rating. On that point, the ratings agencies are probably close, but not quite over the boundary, where they consider downgrading. The very slow forecast reduction in the budget deficit over the next five years, however, still leaves the AAA rating potentially vulnerable.
The “micro” aspects of the budget provide gains for some, notably businesses with a broadening group to pay a lower 27.5% tax rate from July 1st extending over 10 years to all companies paying 25%. Higher income tax payers will benefit from the higher end of the 32.5% income tax threshold extending from $80,000 to $87,000 on July 1st. The deficit reduction 2 percentage point income tax surcharge also falls out of place on July 1st, delivering a bigger tax cut for those on the highest income tax scale. The most notable losers in the budget are smokers, facing annual increases of 12.5% in excise through to 2021 and those with very big superannuation balances. The new life-time cap of $500,000 on non-concessional superannuation contributions effective immediately plus the $1.6 million total cap on transferring from accumulation to tax free pension phase from 1st July 2017 probably mean that high net wealth individuals will use negative gearing even more than they do currently for tax planning purposes. Residential property comes out as the back-handed winner from the superannuation capping exercise.
