Bill Evans: “Underwhelming” Budget to trigger rate cuts

On Tuesday we noted a significant change in the Statement by the Reserve Bank Governor:

“Our research showed that there has been a very significant change in the Governor’s Statement for this month. Recall that Governor Lowe has not changed monetary policy since he became Governor in September 2016. Also note that the key concluding sentence, which has been used in every Statement since October 2016 has been “the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time”. The clear implication behind that statement is an expectation that policy was likely to be on hold for a considerable period. As we have seen, that was an accurate assessment.

In the April Statement, he has changed that language for the first time ever. He still notes that “the Board judged that it was appropriate to hold the stance of policy unchanged at this meeting”. However, he then changes tact with a new sentence. “The Board will continue to monitor developments and set monetary policy to support sustainable growth in the economy and achieve the inflation target over time”. Although, a cursory glance at this sentence might not indicate any change in stance, it does give greater emphasis to the fluidity of the current situation. If this change was not intended, then clearly he would have continued with the approach that has marked his time as Governor.

Therefore this change appears to be a very clear intention to signal that policy is much more ‘live’ than has been the case since the Governor was appointed.

This signal is consistent with Westpac’s expectation that the Board is likely to adopt an easing bias following the May Board meeting. Our thinking behind that approach has been that the Statement on Monetary Policy for May will include a downward revision of the Bank’s growth forecasts. Further support for this view is apparent in the exclusion of the RBA’s current growth forecasts in the April Governor’s Statement. Arguably, this indicates an uneasiness with the 3 per cent for 2019 and the 2¾ per cent for 2020.” This Statement was released before the announcement later in the day of the Federal Budget.

In our note last week, “What impact will the Federal Budget have on monetary Policy” we calculated that the Government would have up to $3bn for a potential cash payout in 2018/19. We also estimated scope in 2019/20 for a spending boost of $7.5bn ($2.5bn from MYEFO’s “allocated but not announced” and $5bn from an improved Budget position in 2019/20). That equates to 0.15% of GDP in 2018/19 and 0.37% in 2019/20.

Ultimately, the announcement of the Budget came in a little less compared to our expectation with net new spending decided at $5.5bn in 2019/20 – 0.27% of GDP.

Given the current headwinds facing the consumer of weak income growth and a negative wealth effect, the most significant issue pertaining to monetary policy decision making is any immediate boost for the household sector.

In that respect, the hallmark spending initiative of the Budget is an expansion to last year’s Personal Income Tax Plan. The additional tax cuts will amount to $19.5bn over the four year forward estimate period to 2022/23, but an already $13.8bn had been put aside in MYEFO.

It’s worth remembering $8.6bn of the $19.5bn personal income tax cut plan expansion does not occur until the final year of 2022/23. In the near-term, the Low and Middle Income Tax Offset (LMITO) will put only $3.5bn (0.27% of disposable income) in consumers’ pockets in 2019/20 when they file their 2018/19 tax returns. Measures included in Budget 2018 offer households a further benefit of $3.8bn (0.29% of disposable income) impacting in the 2019/20 year, though this is funded by other measures, primarily combatting illicit tobacco use.

In Bill Shorten’s budget reply, he offered a higher LMITO – the base increased to $350 from $255 and the maximum benefit kept at $1080 – but it only adds an extra $1bn over four years.

So in any case, we believe this income boost is not large enough to offset falling house prices, low wages growth, rising savings rates and softening global growth.

In regards to any Budget “cash splash”, the result was a decidedly underwhelming total payment in 2018/19 of $360mn. The programme sees payments of $125 per couple (pensioners and others) and $75 per individual, and has now been extended to Newstart recipients. That compares with $500 offered by the Howard government in 2007, to a strong economy where there was little justification for a ‘splash’.

Overall, new measures aside, we need to keep the big picture in mind – the Budget is shifting from a deficit of $4.2bn to a surplus of $7.1bn. Using the aggregate individual tax intake and our disposable income growth forecast of 4.0% in 2019/20, personal income tax as a share of disposable income declines to 17.9% in 2019/20 from 18.1% in 2018/19 – a decrease, but only a modest one.

In assessing any immediate impact to consumer spending, the total LMITO directly amounts to 0.6% of annual household disposable income in 2019/20. The refunds will likely be received early in 2019/20 for last year’s tax returns and are skewed towards low to middle income households who typically have a higher marginal propensity to consume.

However, as our Westpac-MI Consumer Sentiment survey deteriorated in March to its lowest level since September 2017, we believe the consumer will be cautious, corresponding to a relatively low spending rate of the tax cuts which limits the overall impact. Our post Budget survey released on 10 April will be important to assess if the mood has changed.

Outside of these direct initiatives for household incomes in the coming financial year, other major new spending programmes centre on infrastructure and health. While we acknowledge this will provide much needed services for a growing population, in assessing the immediate impact on the economy, their effect is protracted and will have a more minor influence on 2019/20.

The upcoming Federal election – reportedly set to take place on May 11 – represents an unknown given the potential for a bidding war to emerge. Major changes to announced policy by the government would appear unlikely and the RBA is likely to see any bidding war as a temporary “sugar hit” that will not generate sustained higher income growth. The RBA is also likely to look through the near-term personal income tax relief and cash payouts for energy bills.

As such, Westpac sees fiscal policy as having only a modest impact in the near term and continues to expect cash rate cuts in August and November to cushion the economy against the headwinds of 2019.