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Chalmers fights inflation, will it be enough for a rate cut?

  • Written by John Hawkins, Senior Lecturer, Canberra School of Politics, Economics and Society, University of Canberra
The Conversation

Treasurer Jim Chalmers promised an “inflation-fighting and future-making budget” and he has delivered by introducing measures aimed at directly bringing down inflation.

Combined, his A$300-per-household energy rebate and his 10% increase to the maximum rate of Commonwealth Rent Assistance will cut inflation in the year ahead by 0.50 percentage points, or so his forecasts say.

This means during 2024-25 inflation is forecast to be 2.75% and within the Reserve Bank’s 2-3% target band rather than 3.25%.

If the Reserve Bank is as good as its word, and prepared to cut interest rates as inflation moves back towards its target, we can expect a rate cut within the year.

Weak economic growth

Chalmers says he is treading a “responsible middle path” helping those most struggling with the higher cost of living and keeping us out of a recession, without spending so much he stimulates the economy excessively and drives inflation back up.

Economic growth is projected to pick up from an estimated 1.75% in 2023-24 to 2% in 2024-25 and 2.25% in 2025-26.

The main boost to consumer spending will come from the long-planned Stage 3 tax cuts. The government modified these earlier in the year so all taxpayers will benefit rather than just those on higher incomes.

It says they will add 1% to household disposable incomes.

Another change that may support consumers is more than three million Australians will have $3 billion less student debt.

It will now be indexed to whichever is lower, the Consumer Price Index or wages, rather than always the Consumer Price Index. The change will be backdated to June last year when wages growth was lower than prices growth, slashing the increase to apply from July this year from 7.1% to 3.2%.

Chalmers says the Future Made in Australia program – a plan to capture the economic benefits of moving to net zero – will cost $23 billion over the next decade. But less than $3 billion of that cost appears in the budget forecasts, which stretch over four years.

Employment is forecast to grow by only 0.75% during 2024-25, down from 2.25% during 2022-23. With the population growing faster, this will still mean the unemployment rate climbs to 4.5% by mid-2025.

Weak global outlook

Treasury expects the global economy to expand by a mediocre 3.25% over the next three years .

Growth in China, our largest customer, is expected to slow from 5.2% in 2023 to 4.25% in 2025 and 2026, reflecting problems in China’s property market.

The forecast underpins an expected halving of iron ore price from its recent peak. In accordance with its usual practice, Treasury assumes iron ore and coal prices will fall back to their “long-run anchors” by early 2025.

This usual practice has meant that for quite some time Treasury has under-estimated the prices of Australia’s main exports, and therefore underestimated company tax.

While this might occur again, the troubles of the Chinese property sector make a big fall in the price of iron ore more plausible this time.

Inflation and interest rates

Wages are expected to climb faster than prices over the forecast period but not so fast as to themselves put pressure on inflation.

Wage growth is forecast to slow from 4% during 2023-24 to 3.25% in 2024-25 and 2025-26. If things work out as planned, inflation will be back within the Reserve Bank’s 2-3% target band by the end of this year, falling to 2.75% by the middle of next year and 2.5% by mid 2027.

Of course, the Reserve Bank’s latest forecasts do not take into account the measures announced by Chalmers in the budget.

If the forecasts are correct, the Reserve Bank is likely to cut interest rates sooner than the market expects, either late this year or in the first half of next year.

Critics will argue any measures which give households more money, even in the form of electricity price rebates, will add to inflation down the track.

But are the measures really large enough to materially add to inflationary pressures? Perhaps not. They amount to $3 billion out of total spending of almost $700 billion in 2024-25.

Another possible source of inflationary pressure is capacity constraints in the construction industry.

Read more: Inflation is slowly falling while student debt is climbing: 6 graphs that explain the CPI

The Future Made in Australia package involves considerable infrastructure spending, and the budget also spends more on housing and on transport infrastructure. All will need skilled and unskilled labour.

At the same time, cuts to immigration will make a smaller contribution to expanding the construction workforce.

The government is forecasting net overseas migration of about 260,000 per year in the years ahead, down from 528,000 in 2022-23.

While elsewhere in the budget there are funds to train more construction workers, it will take a while for them to join the workforce.

An early budget next year?

Next year’s budget is likely to be brought forward to March to accommodate an election in May.

According to this budget, things will be looking pretty good by then – good enough for the Reserve Bank to feel much more comfortable about inflation and to have started cutting interest rates.

Read more: Chalmers is bitten by the giveaway bug in a budget that contains good news for almost everyone

Authors: John Hawkins, Senior Lecturer, Canberra School of Politics, Economics and Society, University of Canberra

Read more https://theconversation.com/budget-2024-chalmers-fights-inflation-will-it-be-enough-for-a-rate-cut-229274

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