THE BIG PICTURE: Why Swan’s smart budget leaves work to do

The federal budget has come and gone for another year. And it was by no means the much-touted “horror” budget. So how did the government manage to achieve the apparently unachievable of turning a budget deficit of $44 billion – or 3% of GDP – into a small surplus?

That’s something that hasn’t been achieved in 60 years. In large part it has been achieved by cancelling, revising or delaying proposed programs or initiatives.

Yes, there is a fair bit of clever accounting to achieve the outcome but, if all goes to plan, the desired outcome will have been achieved; and without causing major pain in the community.

In fact, low-income earners will be getting dollars in the pocket. Most high-income earners and big business will get nothing. Still, they weren’t really expecting anything – in fact, most were bracing for pain.

What is clear is that budgets continue to shift away from economic documents to political and accounting documents. The economics is only there because it provides the assumptions on which the budget is based. And this year the assumptions are very credible, in fact conservative.

The government is to be commended for doing some real cutting – policy measures actually improve the bottom line. But it is important to stress that not much has to go wrong in order to threaten the wafer-thin budget surplus.

Overall it is a smart budget, but still one that leaves a lot of work for the future. There is only so much that you can delay, revise or push into the future.

So what does it mean for the sharemarket? Nothing directly, but uncertainty has been removed. The budget is over for another year and the projection of a budget surplus may generate some confidence.

What does it mean for interest rates? Well the government is cutting spending and taking dollars out of the economy.

So, at the margin, it allows the Reserve Bank to cut rates again. Still it is only one of the factors it will consider.

Certainly there is a raft of small changes to superannuation, business taxes and government payments, so it is worth digging into detail or getting your investment adviser or planner to advise the impact.

The week ahead

With the federal budget out of the way, it is now back to the regular weekly offerings of economic data and speeches by key officials. In the coming week consumer sentiment and wage data are highlights, while in the US there will be a healthy spattering of top shelf economic data released.

The week kicks off on Monday with figures on home loans. The number of home loans has fallen for two straight months and, on our figuring, it will be three in a row in March. We expect that the number of loans to owner-occupiers fell by 2% in the month, while the value of loans may have fallen by 1%. Clearly the housing market is soft, which is one of the reasons why the Reserve Bank slashed rates.

On Monday, RBA deputy governor Philip Lowe delivers a speech to the ADC Future Summit. And, on Tuesday, the minutes of the Reserve Bank board meeting held on May 1 will be released. We probably aren’t going to learn much that is new, but the document will still be scrutinised.

Also on Tuesday, the Bureau of Statistics releases data on car sales. Industry sales data has already been released and the Federal Chamber of Automotive Industries believes that sales lifted 7.6% once seasonal factors are taken into account. This may be yet another indicator showing that consumers are spending again.

On Wednesday, Westpac and the Melbourne Institute issue the May consumer confidence report. This will be the first time this report has covered reaction to the rate cut and federal budget. However, it’s worth noting that the Roy Morgan weekly consumer sentiment index will actually be the first survey to gauge rate cut reaction.

Also on Wednesday, the wage price index will be released alongside figures on lending finance and imports. We expect that wages lifted by only 0.9% in the March quarter to stand 3.6% higher than a year ago. Provided wages are growing slower than inflation plus productivity, the Reserve Bank won’t be worried. The inflation target is 2-3% and productivity is around 1.0%, so the situation is fine for now.

On Thursday, detailed labour market data will be issued together with average weekly earnings – the latter providing a dollar figure estimates on wages.

In the US, after a quiet day on Monday the economic diary springs to life on Tuesday with consumer prices, retail sales, capital inflows and the Empire State index all scheduled for release. Economists believe that core inflation (which excludes food and energy) lifted 0.2% in April to stand 2.3% higher than a year ago. And retail sales are expected to have lifted 0.3% in April after a solid 0.8% increase in March.

On Wednesday, data on industrial production and housing starts are released, while minutes on the April 24, 25 Federal Reserve policymaking meeting are also issued. For the past two months, starts and building permits have moved in opposite directions. And economists expect that this continued in April, with starts up almost 3%, but permits easing 5% after two months of solid gains.
The Federal Reserve minutes will be important in trying to get a sense of how close policymakers are to easing policy again via quantitative easing – buying back securities in exchange for cash.

On Thursday, the usual weekly data on claims for unemployment insurance are issued – a key gauge of the health of the job market. And on the same data the leading index is released together with the influential Philadelphia Fed index. The leading index is tipped to rise 0.2% in April after a 0.3% gain in March. Economists have also tipped a modest improvement in the Philly Fed index.

Sharemarket, interest rates, currencies and commodities

Australia has generally been regarded as an advanced economy with higher-than-average interest rates.

In large part, Australian rates have been higher than in other countries because it has had higher population growth, higher economic growth and higher inflation. Population growth is still above average, but productivity has been lacklustre. And Australia is gaining a better reputation as being a low-inflation economy.

These factors suggest that interest rates can come down – in a structural sense – with adjustments to what is regarded as “normal”. The economy is only growing a 2.3% at present, but arguably the current “speed limit” is probably closer to 2.75% than the previous “normal” range of 3.0-3.5%.

At the same time, Australia is gaining kudos from its below-average budget deficit and government debt position.

As a result Australia’s AAA debt is in strong demand. The Australian 10-year bond yield fell to fresh 61-year lows yesterday at 3.37%. It’s worth noting that you only have to go back to late March and yields stood a percentage point higher at 4.39%. Similarly, three-year bond yields have fallen to 2.69% – not far from record lows of 2.63%.

At the same time, the overnight indexed swap market is pricing in the cash rate falling from 3.75% currently, to 3.0%. In this sort of environment with both short and longer-term interest rates falling, there is downward pressure on the Aussie dollar. And, indeed, parity could be revisited in the short term.

Good news or bad news? Most businesses would say it is no contest; a lower Aussie dollar is good news, certainly helping beleaguered manufacturers and retailers to compete against imports.

Craig James is the chief economist of CommSec.


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