UBS: No fiscal coming, RBA forced to cut

Via the excellent George Tharenou at UBS:

Treasurer Frydenberg will soon release the Commonwealth Budget update (MYEFO), likely on December 16. Positively, the Final Budget Outcome for 18/19 already beat April’s Budget estimate by a significant $3.5bn (UCB basis), with the $0.7bn deficit outcome (i.e. ~’balanced’) the smallest since the GFC. Furthermore, monthly data for 19/20 so far (up to Oct-19) is tracking broadly in line with the Budget’s implied monthly profile, which underpins their assumed path to a $7.1bn surplus. But negatively, the deficit in the first 4 months of the YTD is still large at $14.7bn, similar to last year.

Hence, the Budget assumes in the next 8 months a material $22bn improvement; which is a much larger than normal ‘seasonal’ lift; albeit partly reflecting the pullforward of tax refunds that ‘roll off’ in the rest of 19/20. This suggests MYEFO has little scope for an upside surprise/beat (vs the Budget projections); and hence there is limited room (if any) for further fiscal stimulus, without deteriorating the forecast surpluses.

The current year tracking in 19/20 likely reflects the boost from a better than expected iron ore price; but broadly offset by a weaker coal price, & slower GDP & consumption. While the Budget could upgrade their iron ore price forecasts, we think they will remain relatively conservative & project prices only gradually decline towards ~$60/t (CFR) over coming years. Nominal GDP forecasts are already optimistic & unlikely to be revised up. Only ~$3bn (~0.1% of GDP) of new spending/stimulus since Budget, so far Given the ~’neutral’ impact from ‘economic parameters’ on the Budget ‘starting point’; but more importantly the Government’s reiteration of a surplus profile; we still expect limited new fiscal stimulus in MYEFO.

Our view remains the 20/21 Budget (due May-20) will announce ~$10bn of household tax cuts, effective from Jul-20. Amid the worst consumption & GDP since the GFC, there are calls for the Government to do more, & pull forward ~$22bn ‘phase 2’ tax cuts, from 22/23, to Jul-20. However, even though the Budget is in balance, & Government debt is low by intentional standards, we still think the risk of an upside surprise from material fiscal stimulus is now limited. This reflects the Government’s commitment to surplus, amid press reports that S&P said if “fiscal stimulus involves substantial spending initiatives & changes the trajectory of the budget, then doing so could increase downward pressure on [Australia’s AAA] rating & outlook”.

RBA Governor Lowe today noted Q3 GDP’s “surprise was that consumers decided to save a fair share of that extra income” from tax refunds & rate cuts; but optimistically reiterated he’s “still confident that over time, people will spend this extra income”. However, our analysis shows the response of the economy to rate cuts ‘this time is different’, at least so far. Indeed, we continue to expect the economy will disappoint the consensus and the RBA, and that further policy stimulus in needed. Hence, with material fiscal stimulus remaining unlikely in MYEFO, we still expect the RBA is highly likely to cut the cash rate by 25bps in Feb-20; with another 25bps to 0.25% by mid2020 remaining conditional on further global central bank easing.

Yep. And as iron ore corrects, Frydenberg may well cut.

David Llewellyn-Smith
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