Australia’s budget is banking on wages outpacing inflation and interest rates, but not by too much

Australia’s near-term economic fortunes hinge largely on household incomes rising at a faster pace than inflation but not so fast that they prompt an overly rapid series of interest rate increases by the central bank, according to the 2022-23 federal budget.

The delicate balance is at the heart of a budget – and election campaign – strategy that relies on an assumption additional handouts in the form of fuel excise relief and an expanded tax offset for mostly middle-income taxpayers don’t fan inflation further.

Even while the Morrison government can justly point to Australia outperforming many of our developed peers, the country’s economic dynamism is predicted to slow rapidly, with GDP growth in 2022 of 4.75% halving and then some to 2% next year.

The main bragging point of a jobless rate dropping to 3.75% by September – the lowest since 1974 – could be a sore spot if wages end up lagging inflation by 1.5 percentage points during 2021-22, as the budget predicts. Much faster growth, though, will place greater onus on the Reserve Bank to lift the cash rate quicker lest inflationary expectations become “unanchored”, as the budget papers state.

The budget, though, does carry some upside risks, such as an outlook based on commodity prices falling back to more normal levels by September.

Treasury has made conservative predictions before, and they may prove so again given iron ore prices remain about triple previous forecasts, while distortions to global markets caused by Russia’s invasion of Ukraine – that propelled coal to record highs – don’t look like subsiding soon.

Despite these caveats, the budget is confident about Australia’s resilience and that the country will continue to fare better than most others, including keeping inflation in check. Even the ongoing floods in Queensland and NSW will barely dent growth.

“The Australian economy has proved remarkably resilient to the ongoing impacts of the pandemic, consistently outperforming expectations and exceeding pre-pandemic levels of activity by more than the major advanced economies,” the budget papers state.

Shoring up households will be the extra $420 added to this year’s low and middle income tax offset, lifting it to $1,500 for this fiscal year. The government had dangled culling the temporary outlay as a sign of its fiscal rectitude but that turned out to be a $4.1bn red herring of extra spending, not a saving of about $8bn.

Other headline measures to ease the cost of living pressures include $1.5bn to provide a one-off, tax-exempt payment of $250 to six million eligible pensioners, welfare recipients, and others. Likewise, a six-month halving of the 44.2 cents a litre fuel excise will cost $3bn over the forward estimates, but at least this measure will trim inflation by 0.25 percentage points this year.

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Despite that additional spending – and other programs – the budget expects inflation to “peak well below that in most other advanced economies”. It doesn’t say what that peak is, but by June, consumer price will be at 4.25% before subsiding to 3% by June 2023 and 2.75% by a year later.

By contrast, the wage price index will lag with a 2.75% reading for this fiscal year – implying a real reduction of 1.5 percentage point – before exceeding CPI in the following year with a 3.25% rise, and then quickening to 3.5% for the following two years and exceeding inflation.

Economists, though, are already predicting consumer prices will be rising at a 5% clip by mid-year, and that the RBA will soon start to respond by jacking up the cash rate from its record low of 0.1% that it has sat at for 15 months.

As ANZ recently noted, “the last time the RBA increased the cash rate was 2010, so many borrowers have no experience of rising mortgage rates”.

Just how much rates will rise is hard to predict but the CBA – Australia’s largest mortgage issuer – predicts the RBA will keep lifting them until they reach 1.25% by the first quarter of next year.

“However, if fiscal policy ends up more stimulatory than we anticipate and the government injects a material amount of policy support to deal with ‘cost-of-living pressures’ we may need to upwardly revise our forecast profile for the cash rate in 2023,” Gareth Aird, the CBA’s head of Australian economics said before the budget.

RateCity.com did some number crunching based on the CBA’s prediction that the RBA’s cash rate will rise from the record low 0.1% to 1.25% by next February.

They found the average new home loan customer in Australia would see their monthly repayments rise by an estimated $381 by February next year.

In New South Wales, repayments would rise by an estimated $495 a month by February, assuming their loan size is $804,675. (That’s the average recorded by the ABS for January.)

The calculation also assumes the mortgage holder is on the average RBA new customer variable interest rate of 2.52% and has a 30-year owner-occupier principal and interest home loan.

The budget papers don’t predict where interest rates will go, only that they assume they “move broadly in line with market expectations”.

As of Monday, though, investors were predicting the RBA’s rate could reach as high as 3% by August 2023.

“Our analysis indicates that a cash rate of 2.50% is deeply contractionary and would result in mortgage payments as a share of household disposable income rising to a record high,” the CBA said before the budget, using data going back to 1999.

The Morrison government, of course, is banking on one aspect of those rate rise forecasts being right: that they don’t start until June, or after the election.