Australia's Budget Measures May Impact RBA's Interest Rate Decisions

Key Takeaway

• Australia's budget measures, including energy rebates and rent assistance, aim to reduce inflation but may prompt the RBA to keep rates high longer.
• Fiscal expansion shifts from a surplus to a A$28.3 billion deficit by 2025, potentially complicating RBA's inflation control efforts.
• Market reactions adjust RBA rate hike expectations, with potential cuts now seen more likely in the first half of 2025.

Interest Rate Outlook

Australia's central bank, the Reserve Bank of Australia (RBA), is anticipated to maintain higher interest rates for an extended period, despite the government's recent budget forecasting a decline in inflation to within the target range of 2-3% by the end of the year. This forecast is primarily attributed to the Labor government's introduction of energy rebates and rent assistance, expected to reduce inflation by 0.5 percentage points to 2.75% by December, from 3.6% in March. However, economists express concerns that the government's cost-of-living assistance, including a universal A$300 ($200) power subsidy and upcoming tax cuts, might inadvertently fuel further inflation by increasing consumer spending.

Fiscal Policy and Inflation

The budget presented by the center-left Labor government outlines a shift from a surplus of A$9.3 billion in the current fiscal year to a deficit of A$28.3 billion in fiscal 2025, doubling the deficit forecasted in a Bloomberg survey. This expansionary fiscal stance is expected to pose challenges for the RBA, with some economists suggesting it could complicate the central bank's efforts to control inflation. The budget's impact on inflation and the broader economy has sparked a debate among economists, with some warning that the fiscal measures might slow the pace of disinflation and delay potential monetary easing.

Market Reactions and Economic Forecasts

Following the budget announcement, market reactions have been mixed, with some adjustments in expectations for the RBA's monetary policy. The Overnight Index Swap (OIS) contracts now indicate a decreased likelihood of a rate hike in the near term, with a slight chance of an increase in June or August. Additionally, the market has adjusted its expectations for a rate cut, now more likely in the first half of 2025. Despite the government's efforts to curb inflation through fiscal measures, concerns remain about the long-term impact on bond yields and the depth of the RBA's easing cycle.

Street Views

• Luci Ellis, Westpac Banking Corp (Neutral on Australia's interest rate outlook):

  "The dominant risk continues to be the trajectory for inflation, the demand support from fiscal measures potentially slowing the pace of disinflation and delaying the point at which monetary easing comes into frame."

• Shane Oliver, AMP Capital Markets Ltd. (Cautiously Optimistic on Australia's fiscal policy impact):

  "The net effect adds to the risk of higher for longer interest rates."

• Prashant Newnaha, Toronto Dominion Bank (Neutral on RBA's future actions):

  "The RBA hiking in the second-half of this year cannot be ruled out."

• Devika Shivadekar, RSM Australia (Bearish on Australian economic strategy):

  "Any decline in inflation will be 'artificial rather than transformational.' The RBA may be compelled to contemplate interest rate hikes, with the intention of directing the surplus funds toward mortgage repayments rather than discretionary expenditures."