Overly optimistic Budget leaves risks skewed towards rate cut

Last night’s Federal Budget speech offered a typical array of contentious proposals, some more surprising than in previous years, but ultimately the silver bullet to ignite Australia’s ‘animal spirits’ was lacking. Importantly, Treasury’s balance projections were heavily reliant on overly optimistic estimates that depend on increased revenues rather than reduced spending. More specifically, forecasts for wages (which account for two-thirds of revenues) were reminiscent of ‘boom time’ figures: Current wage growth of sub 2% is far below the projected 3% for FY18 and 3.75% for FY21. In turn, this leaves the predicted surplus as a dubious proposition.

On the proposed bank levy, when combined with recent APRA-induced hikes, there will likely be more pressure on mortgage rates. The Reserve Bank will welcome this on the feverous investor side, particularly for interest-only loans, but not on the struggling owner-occupier segment. At the margin, this increases the chance of a 0.25% rate cut later this year, where banks will likely pass on nothing to the former and only 0.15% to the latter. This would be a much easier means to reclaim lost margin than another out-of-cycle mortgage rate hike.

Regarding the potential impact on the country’s valued AAA credit rating, we believe it will remain on negative outlook for now. Alongside several other factors, Australia’s heavy external debt burden will keep risks skewed to the downside. Ultimately, we believe a downgrade will be delivered. The decision has just been delayed, partly because of the retirement of a senior S&P figure rather than an improvement in economic fundamentals.

What is not expected to change significantly is the upward trajectory of federal debt, with Treasury forecasts kept similar to prior estimates. This will see the $500 billion milestone surpassed during the year. While concerning for some, in a world awash with debt it is manageable for now.

Overall, given our expectations that housing will cool and sluggish wage growth will persist, we still look for rate cuts early next year and this Budget has not changed that view.

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