Australian Federal Budget 2024/25: Competing pressures

The Australian Federal Budget for 2024/25 was handed down by the treasurer in Canberra this evening. The sizeable revenue upgrades that have driven the budget into surplus for two years in succession are moderating as pressures on governments at the federal and state levels to deliver key services and infrastructure are driving up the outlook for spending. In the short term, the government has prioritised delivering cost-of-living support, set to provide around $9.5bn of stimulus in 2024/25. 

Budget 2024/25 | Fiscal Position

Although Australia will post a second consecutive budget surplus in 2023/24, larger deficits are now expected in the coming years. Following a $22.1bn surplus in 2022/23, a $9.3bn surplus is forecast for the current financial year - upgraded from a $1.1bn deficit anticipated in the Mid-Year update (MYEFO) published last December. As the chart below shows, so-called cyclical factors have swung the budget into surplus over the past couple of years. Resilient economic conditions; very low unemployment; and elevated commodity prices are key factors that have contributed to delivering a revenue windfall to the government.  

This has put Australia in an unusual position among peer economies in running twin surpluses; the current account has been in surplus for an extended period that now dates back to mid-2019. 

However, with the economy slowing, commodity prices set to retrace and structural pressures on the nation's finances intensifying, the budget is expected to fall back into deficit in 2024/25 (-$28.3bn) and remain in the red through the forward estimates. These structural pressures on the Budget were identified in the 2023 Intergenerational Report and include spending associated with climate change, an ageing population, regional security and the increased demand for care and support services. Cumulatively, deficits to 2026/27 are now forecast to run to $88.5bn, a deterioration from the $74.6bn in deficits anticipated in MYEFO. 

The deterioration comes about due to revenue windfalls moderating alongside rising government spending. Government receipts are now expected to peak at 25.8% of GDP this financial year (up from 25.6% in MYEFO) but to then slow to 25.1% of GDP by 2026/27. By contrast, government payments - although revised down to 25.4% of GDP in 2023/24 from 25.7% in MYEFO - have increased across the forward estimates to a peak of 26.6% of GDP in 2025/26.   

As a result of the deterioration to the fiscal outlook, the profile for net debt has also worsened relative to the forecasts in the MYEFO. From 18.6% of GDP in 2023/24 (18.4% previously), net debt grinds higher to 21.8% of GDP in 2026/27 (up from 20.8%).    

Budget 2024/25 | Policy Measures 

New policy measures announced in the Budget are framed around providing support for the cost of living (including the stage 3 tax cuts) as well as in other areas such as defence and aged care and for the government's initiative to revive local manufacturing to assist with the net zero transition. The net cost of these measures is substantial - $9.5bn in 2024/25 for a total of $23.2bn to 2026/27. Major items include: national defence ($5.7bn over 4 years), energy bill relief ($300 rebates to every household, total cost $3.5bn over 3 years); new Pharmaceutical Benefits Scheme listings ($3.4bn over 5 years); road and rail infrastructure ($2.9bn over 5 years); Future Made in Australia initiative ($2.6bn over 5 years); aged care ($2.2bn over 5 years); Commonwealth rent assistance ($1.9bn over 5 years); Stage 3 tax cuts ($1.3bn over 5 years).  

Budget 2024/25 | Economic Outlook

The evolution in Treasury's economic forecasts since the 2023/24 Budget is presented in the table below. Alongside a slowing global economy, the outlook for domestic growth has been revised lower. This results in softer employment growth over the next couple of years; however, the path for the unemployment rate is little changed - signalling a soft landing scenario remains the central view. A retracement in commodity prices sees the terms of trade fall but at a slower pace than earlier forecast.   

The major point of contention in this budget is around the inflation outlook. As a result of the government's energy bill relief and rent assistance, Treasury forecasts inflation could be back inside the RBA's 2-3% target band by the end of the year, with these measures expected to deduct around 0.5ppt from headline CPI in 2024/25. This is a faster timeline than forecast by the RBA (second half of 2025) and is contentious in the sense that these measures could free up households to boost spending in other areas. 

Macro (Re)view (10/5) | RBA remains neutral

European equities stood out this week posting strong gains to close at or near record highs. US equities and most Asian indices saw steady rises. Moves on key currency crosses were limited, though the US dollar rebounded against the Yen following last week's interventions by the authorities in Japan. US CPI data is the key risk event next week, while in Australia the Federal Budget and reports on wages (Q1) and the labour market (April) are ahead.   

There was lull of key events out of the US this week, leaving markets continuing to trade the narrative of April's softer-than-expected payrolls report validating dovish Fed messaging on 2024 rate cuts. This will be put to the test next week with CPI and retail sales data due on Wednesday. Producer prices (Tuesday) will give markets an early steer to the CPI outcome. Meanwhile, Chair Powell is set to speak in Europe (Tuesday), headlining a busy week of appearances from other Fed officials, notably NY Fed President Williams (Thursday) and Governor Waller (Friday).   

The Bank of England's Monetary Policy Committee (MPC) held a steady hand on interest rates (5.25%) and on its guidance that policy "needs to be restrictive for an extended period" at this week's meeting, but with the MPC sounding less concerned about the risks of inflation remaining persistently elevated the easing cycle appears to be nearing. Post-meeting rates pricing indicates the timing of the first cut is a close call between June and August, set to swing one way or the other on the upcoming data. Meaningful steps towards the easing cycle were inferred from developments including the MPC's 7-2 vote (as Ramsden joined Dhingra in voting for a cut); new forecasts projecting inflation to fall below target over the next couple of years; and dovish comments from Governor Bailey at the media conference, notably that it was "likely" rates would need to be cut "over the coming quarters" and that it was possible more cuts would be needed than is currently priced into markets. 

Those comments about the potential for lower interest rates was in the context of downward revisions to the inflation outlook in the May Monetary Policy Report. Conditional upon the market-implied path for the BoE's interest rate, inflation is projected to come back to the 2% target within a two-year timeframe - two quarters earlier than previously anticipated - and to then fall further to 1.6% in 2027. Governor Bailey's point was that a scenario where interest rates are cut by more than currently priced may be needed if, in the current best judgments of the Bank, inflation risks falling below target by the end of the forecast horizon. A key part of that assessment is that the MPC now assesses that the risk of high inflation persisting due to 'second-round' effects on wages and prices has eased; however, Governor Bailey said there were varying views on this judgment amongst individual MPC members. 

Over at the ECB, the account of the April meeting effectively set out the roadmap to culminate in a June rate cut. For "a few members" there was a strong enough case to cut in April but ultimately the majority of the Governing Council needed a little more convincing. Comments from many ECB officials since that meeting indicate the threshold to cut will be crossed in June. The policy outlook beyond June is highly uncertain, however, and is likely to be conditional upon the ECB staff macroeconomic projections to be updated at the next meeting.   

Attention domestically was on the RBA's policy meeting. The Board's decision to keep rates unchanged (4.35%) was no surprise but there was a strong reaction in markets via a weaker AUD and lower bond yields as the neutral guidance that it was "not ruling anything in or out" was retained and then reaffirmed in the press conference against expectations for a more hawkish lean. Updated forecasts in the May Statement on Monetary Policy lifted the near-term inflation outlook; however, the return to the midpoint of the 2-3% target band remained on a mid-2026 timeframe under a higher for longer cash rate path. More detailed analysis can be found in my review of the RBA meeting here. On the data docket this week, retail trade volumes contracted 0.4% in the March quarter, a weak outturn that underscored the headwinds to household consumption from the increased cost of living and higher interest rates (see here). 

RBA keeps rates steady in May

There were few surprises at today's RBA meeting. Interest rates were left unchanged (cash rate 4.35% and exchange settlement rate 4.25%) and the Board held the line that it "is not ruling anything in or out". Two years on from the start of the tightening cycle, inflation remains well above the 2-3% target band but the Board is content that monetary policy is in a good place to see the job through without inflicting too much damage on the economy and the labour market. With the RBA's messaging defying expectations for a more hawkish tone, the Australian dollar weakened and bond yields declined sharply.

Broadly speaking, my interpretation of today's developments was that the RBA has not lost patience with its strategy, aiming to gradually return inflation to target while preserving the labour market. Governor Bullock said at the post-meeting press conference that a rate hike had been discussed but the Board concluded it was not warranted. This was despite the near-term outlook for inflation rising in the May Statement on Monetary Policy: headline inflation is now expected to end the year at 3.8% (from 3.2% previously) with the core rate at 3.4% (from 3.1%), upgrades that reflect stronger services inflation, a tighter labour market and higher petrol prices. Governor Bullock said the Board could remain "vigilant" to these risks without needing to act now. 

Notwithstanding the higher outlook near term, inflation is still projected to return to the midpoint of the target band by the end of the projection horizon in mid-2026. This is largely because the new assumption for the cash rate in the May forecasts is notably higher than in the February forecasts, reflecting the global repricing of expectations for easing cycles. Imputing market pricing, the May forecasts push back the timing for the first rate cut to mid-2025, ending the projection period in mid-2026 (3.8%) around 50bps higher than assumed in February.

Although the implicit assumption is for the cash rate to stay restrictive for longer, there was minimal effect on the growth outlook other than a slight moderation in GDP growth this year from 1.8% to 1.6%. On the labour market, the RBA has been surprised by the resilience it has seen this year, resulting in its outlook for the unemployment rate being trimmed from 4.3% to 4.2% in 2024 and from 4.4% to 4.3% in 2025. For some time, I had been of the view that the unemployment rate would rise more slowly than the RBA was projecting, so this was an encouraging development. 

Australian retail sales volumes -0.4% in Q1

Following a temporary boost from the Black Friday sales ahead of Christmas, weakness in Australian retail volumes returned falling by 0.4% in the March quarter. The ABS reported this was the 5th decline for retail volumes in the past 6 quarters, with cost-of-living pressures and higher interest rates seeing households cutting back, particularly on discretionary-related purchases. 

Retail volumes (retail sales adjusted for inflation) fell by 0.4% for the 3 months to March. The weakest outcomes were in household goods (-2.9%) and department stores (-0.4%), driving an overall decline of 0.7% across the discretionary categories. However, volumes increased in clothing and footwear (1.3%), cafes and restaurants (0.3%) and 'other' retailing (0.5%). Food volumes were flat in the quarter. 

Over the past year, retail volumes have decreased substantially by 1.3%. This is partly inflated by the post-pandemic rotation to services spending, while new vehicle sales - not a component of the retail data - have also been very strong; however, household demand has unequivocally pulled back in the retail sector as the headwinds from the higher cost of living and RBA rate hikes have impacted. Weaker demand (as well as improvements on the supply side) has seen retail price growth slow materially to a pace around 2.5% in year-ended terms from 6% a year ago. Because prices have kept rising (albeit at a slowing pace), retail spending in nominal terms increased over the past year (1.2%) - despite the large contraction in underlying demand. 

The weakness in retail volumes is especially notable as it has come alongside rapid population growth driven by post-pandemic inward migration. Adjusting for the population increase, retail volumes are even weaker on a per capita basis, falling for the 7th quarter in a row in Q1 (-1%). This leaves per capita volumes just 3.3% above their pre-pandemic level at the end of 2019, compared to a 9.7% increase in headline volumes over the period.  

Preview: RBA May Meeting

The RBA Board is widely expected to leave its key interest rate unchanged (4.35%) at today's meeting (decision due 2:30pm AEST). Aside from the decision, today provides the platform for the RBA to firmly set the narrative on the policy outlook via updated growth and inflation forecasts and at Governor Bullock's post-meeting press conference. 

A recap: RBA leaves all options on the table 

At its March meeting, the Board left the cash rate at 4.35%, a setting unchanged since last November. Over this period of steady interest rates, the Board's guidance has shifted gradually from a tightening bias back in November to a more neutral stance by March where "the Board is not ruling anything in or out". Although this shift has been meaningful, its messaging on policy has essentially remained the same: monetary policy is working to slow demand and bring down inflation but a return to the 2-3% inflation target band is not yet assured. By contrast, markets have been much less stable in their outlook, swinging from pricing in 2-3 rate cuts in 2024 at the start of the year, then expecting no rate cuts, and more recently moving towards pricing in further tightening.  

RBA to hold a steady hand, though a hawkish turn is a risk 

Turning to today's meeting, I think rates will remain on hold, with the Board retaining the line that it is not ruling anything in or out. In March, the risks to both sides of the RBA's mandate for inflation and employment were judged to have become "a little more even" and I don't expect a material change to this assessment today. That view is based upon the Board remaining content that inflation is still projected to return to target "within a reasonable timeframe", currently expected in mid-2026.    

The main risk is that the Board takes a more hawkish turn if the new forecasts (prepared by RBA staff, not the Board) to be published today contain upward revisions to the inflation outlook following the stronger-than-expected Q1 CPI report. Currently, headline inflation (3.6%Y/Y) is projected to ease to 3.3% by mid-year; 3.2% by year-end and eventually near the midpoint of the target band in mid-2026 (2.6%). Similarly, the core rate (4%Y/Y) is seen at 3.6% mid-year; 3.1% year-end; and 2.6% in mid-2026. The RBA's tolerance to a mid-2026 timeframe is subject to the incoming risks it sees, particularly in the areas it has highlighted including services prices and labour costs; if that tolerance is breached then it could hike again, or at least strengthen the signal it sends today that it could do so at an upcoming meeting.   

One factor to consider, however, is that the conditioning assumption used for the cash rate in the new forecasts will be higher than it was in the February Statement on Monetary Policy. In February, the cash rate profile (an amalgamation of market pricing and economists' views) factored in 4-5 rate cuts over the next couple of years to mid-2026, including 2 cuts in 2024. Market pricing now discounts 2 cuts at most by the end of 2025. A higher cash rate track will put downward pressure on the forecasts for inflation and growth while pushing up the outlook for the unemployment rate (3.9% average in Q1), currently projected to rise to 4.3% by year-end and 4.4% by 2025.

Macro (Re)view (3/5) | US outlook takes a dovish turn

Rates pricing in the US shifted notably this week, with markets restoring the prospect of 2024 rate cuts following the Federal Reserve's policy meeting and softer-than-expected employment data. US bond yields rallied and the dollar declined. Most notably, the US dollar fell several figures against the Yen this week as the authorities in Japan intervened (yet to be confirmed) to push against the substantial depreciation in its currency. 

Although the decision by the Federal Reserve's policy-setting FOMC to leave rates unchanged at 5.25-5.5% was seen as a foregone conclusion, the tone of Chair Powell's press conference defied expectations to push back more aggressively on prospects for near-term rate cuts in the US. As it was - and despite recent inflation readings - Chair Powell said the committee viewed monetary policy as well calibrated and that further rate hikes were "unlikely". Additionally, there were credible paths the US economy could take that would warrant rate cuts, despite the data currently not giving the FOMC adequate assurance that inflation is headed back to the 2% target on a sustainable basis. The one tweak the FOMC did make was to slow the pace of balance sheet reduction, from a cap of $60bn/mth to $25bn/mth for its Treasury holdings, effective from June. 

Given the sentiment coming out of the meeting, a nonfarm payrolls report for April that was softer than expected gave markets the green light to renew pricing for rate cuts in 2024. Employment increased by 175k in the month, below estimates for 240k as a net 22k was subtracted off payrolls over February and March. This saw the unemployment rate tick up from 3.8% to 3.9% alongside an unchanged participation rate (62.7%). Perhaps the most impactful aspect of the report was the slowing in average hourly earnings growth from 4.1% to 3.9%yr, a sign that easing tightness in the labour market is reducing wage pressures - albeit that was not the signal markets had taken away from the Employment Cost Index (4.2%Y/Y in Q1) earlier in the week.

Last week, PMI data showed economic activity in the euro area was picking up following a lengthy period of stagnation since the back half of 2022. Consistent with that signal, GDP data for the March quarter came in above expectations expanding by 0.3% (vs 0.1%). Taken together, these are tentative signs that the weak growth over the past year (0.4%) is starting to turn. With the labour market having remained resilient to the economic slowdown (the unemployment rate held at a record low of 6.5% in March) and inflation declining materially, real household income dynamics have improved, likely supporting consumption growth - particularly in the services sector. 

On inflation, the latest data was broadly as expected with the headline HICP printing at 0.6%m/m in April to leave the annual pace at an unchanged 2.4%. Core inflation remains firm to the headline rate at 0.7%m/m and 2.7%yr (vs 2.6%), though it eased slightly from 2.9%yr in March as prices in the key services basket cooled to 3.7%yr from 4%. Overall, markets saw this as validating a June rate cut from the ECB. The ECB's Chief Economist Lane spoke during the week highlighting that the Governing Council is moving towards dialing back restrictive monetary policy and in doing so it is managing "two-sided risks" from easing too quickly before inflation is well contained and staying overly restrictive for too long potentially leading to a downturn.

In Australia, attention turns to next week's RBA meeting. Rates are expected to remain on hold (4.35%), leaving much of the focus around the Board's messaging on the policy outlook that will accompany a revised set of growth and inflation forecasts. Different from the likes of the Fed and ECB, commentary from RBA officials is limited between meetings, so there is an element of uncertainty around whether the messaging that the Board "is not ruling anything in or out" from a policy perspective will be tweaked following the firmer-than-expected Q1 inflation report. 

The activity data published this week suggests that monetary policy is restrictive and is working to slow demand. In a large downside surprise, March retail sales fell by 0.4% driven by a post-summer pullback in spending across discretionary-related categories (see here). Dwelling approvals rose by 1.9% in March but fell to their lowest quarterly total in 12 years, with higher interest rates, capacity pressures and weak sentiment all headwinds (see here). On the other hand, conditions in the established housing market remain hot: housing prices lifted for the 15th consecutive month in April, generating an associated upturn in housing finance commitments of 3.1% in March to a 19-month high (see here), though this more reflective of tight supply than the stance of monetary policy. Meanwhile, the trend of narrowing trade surpluses continued, with the surplus for March ($5bn) retracing to its lowest level in more than 3 years (see here). 

Australian housing finance rises to 19-month high in March

The value of Australian housing finance commitments increased by 3.1% in March, rising to their highest level in 19 months at $27.6bn. Owner-occupier commitments lifted by 2.8% ($17.5bn) and investor commitments advanced by 3.8% ($10.2bn). As noted in today's release from the Bureau, the strong rise in commitments over the past year (17.9%) has reflected an increase in both loan volumes and loan sizes. Strong post-pandemic population growth is a key factor behind the demand for housing, outweighing the effects of higher interest rates and affordability concerns alongside an upturn in housing prices.

Commitments in March lifted by 3.1%, a stronger-than-expected rise (1%) while the prior month was revised up to a 1.9% increase (from 1.5%). The figure for March came to $27.6bn, its highest since August 2022 and up more than 19% from the cycle low in January 2023. This rebound has come alongside strong demand for housing generated by post-pandemic population growth and by rising housing prices; earlier in the week, the CoreLogic group published data showing that housing prices on a national basis have risen for 15 months on end since January last year, an increase of 11.1% over the period. 

The upswing in commitments, however, slowed sharply over the first quarter of the year, rising by 0.5% compared to growth in the final two quarters of 2023 of 3.5% (Q3) and 6.7% (Q4). That increase in Q1 was driven by a 2.3% rise in investor commitments (to $29.5bn) as owner-occupier commitments declined modestly by 0.4% (to $51.2bn).   

In the owner-occupier segment, the decline in commitments in Q1 factors in loan volumes that were broadly lower across the segment when compared with the previous quarter: upgraders -1.3%, construction-related -1.1% and first home buyers -2.8%, though this could partly reflect seasonal weakness (over and above what the ABS can account for). 

Investor lending remains on the rise and lifted back above $10bn in March, a 22-month high. Very low vacancy rates as well as rising rents and housing prices are supporting activity in this segment.   

Refinancing, down 2.5% in March, continues to unwind from its highs driven by the RBA's hiking cycle. Since reaching a peak of $21.5bn in July last year, the value of refinancing has retraced by around 25%. 

Australia's trade surplus narrows to $5bn in March

Australia's surplus on goods trade declined to $5bn in March, its narrowest level in more than 3 years. Import spending has accelerated over recent months, partly driven by a weaker Australian dollar, while export earnings have held up despite falls in key commodity prices as shipment volumes rebounded from earlier weather-related disruptions. 

The goods surplus for March came in at $5bn after falling from $6.6bn in February (downwardly revised from $7.3bn). This continues the trend of narrowing surpluses over recent months - the surplus for Q1 contracted by more than 25% to $21.3bn, its lowest quarterly aggregate since Q4 2020 - driven by a sharp rise in import spending as export earnings broadly flatlined.   

Exports for March were little changed (0.1%) at $44.9bn around broadly offsetting contributions from rural (2.8%) and non-rural goods (-0.4%). For the quarter, exports fell by 0.9% to $136.1bn. This decline was driven mainly by non-rural goods (-2%) as iron ore and coal prices retraced and shipments were disrupted by cyclones early in the new year (before rebounding in March). 

Import spending posted a 4.2% rise to $39.9bn, the fourth consecutive month-on-month increase. This was led by an 8% surge in capital goods while consumption and intermediate goods both rose by 4.1%. In Q1, the value of goods imported lifted by 6% to $114.8bn, a record high. A factor within that rise is a lower Australian dollar (making imports more expensive), which fell by around 1.8% on a trade-weighted basis in the quarter. Consumption goods rose by 10% in the quarter with new vehicles (7.7%) and clothing and footwear (13.7%) playing prominent roles; capital goods (5.8%) and intermediate goods (3.6%) also advanced in Q1, the latter rising despite a slide in fuel imports (-3.3%). 

Australian dwelling approvals decline to 12-year low in Q1

Australian dwelling approvals lifted by 1.9% in March, their first rise since November last year but coming in short of expectations for a 3% increase. Ongoing headwinds in the home building sector due to factors such as higher interest rates, capacity pressures amid a sizeable housing pipeline and weak sentiment associated with increased insolvencies drove quarterly approvals to a 12-year low. 

Dwelling approvals increased by 1.9% in March (12.9k), stemming a run of three consecutive month-on-month declines. However, that increase underwhelmed expectations for a 3% lift, and approvals still contracted by a sizeable 9% over the first quarter to 38.5k. This was the lowest quarterly figure for approvals in 12 years. Even though house approvals lifted by 3.6% in March following a 12.2% gain in February, the segment was still saw a 3.4% decline in Q1 to 25.4k. Meanwhile, unit approvals were down 1.8% in the latest month contracting by 18.2% overall in Q1 to 13.1k, a low back to Q1 2012. 

Detached house approvals across the capital cities remain very low. House approvals in Q1 in several cities were around the lows seen at the outset of the pandemic.  

The value of residential alterations approved remains high and was little changed through Q1 (-0.2%) at $3.1bn. By contrast, non-residential approvals (including office, retail and industrial buildings) extended their decline from the back half of last year falling by a further 6.9% in the first quarter ($14.3bn). 

Despite rising in March, dwelling approvals showed further weakness over the first quarter of the year as a range of headwinds continue to impact the home building sector. Builders have been focused on working through the sizeable number of homes under construction that accumulated during the pandemic period, with the low level of approvals indicative of a reluctance or inability to add much further to the pipeline, despite population growth running at a well above average pace.