Daily Commentary BY THE CURVE TEAM –

Budget Evenly Balanced

9th of May, 2018

The latest budget was finally handed down by the government overnight, delivering the tax cuts as promised, as well as a path back to surplus. It was very much a balanced budget, as it should be at this point in the cycle, but remains remains highly contingent on one key factor.

According to the budget papers, the government’s budget will be back in surplus in 2019/21 while still delivering tax cuts for the majority of Australian’s. Prudently, the bulk of the tax relief is in the outer years when there will be more clarity over the sustainability of the pick up in tax revenue. This gives the government some room to move if tax receipts fall short of expectations.

Looking at the assumptions that underpin the budget, the forecasts for growth and unemployment vary only slightly from the RBA’s most recent updated outlook. The Treasury’s growth forecast is a little more cautious than the RBA, but only marginally. Meanwhile they are a little more optimistic on the unemployment rate.

The key to both the growth outlook from the Treasury and the RBA, is that they need to see a credible increase in wages for their forecasts to be realised. The RBA also needs wage growth to boost inflation while the Treasury needs wage growth to underpin consumption and tax receipts.

Here’s where the risk is. Both the RBA and Treasury forecast unemployment to remain above 5% throughout the forecast period. The problem here is the 5% level has long been assumed to be where full employment, or the NAIRU (non-accelerating inflation rate of unemployment). The Treasury actually expects wages to rise to an annual rate north of 3% without unemployment falling through 5%.

Recent evidence from offshore suggest both the RBA and Treasury might be a little too optimistic. In a number of countries unemployment rates have fall below levels previously believed to be the rate of full employment, yet wage growth has failed to materialise.

Time will tell if both the RBA and Treasury’s forecasts prove to be too optimistic.

David Flanagan

Director - Interest Rate Markets