UBS: Budget to bring rate hikes

Via the excellent George Tharenou:

Budget: only $8bn budget improvement over 5 years; given $96bn stimulus
The Australian Government Budget, relative to the MYEFO released in Dec-20, forecasts a far smaller than expected cumulative improvement over the 5 years to 24/25 of only $8bn. Positively, 20/21 is a material $37bn better at $161bn (UBSe: $148bn, mkt: ~$160bn), or 7.8% of GDP (was $198bn or 9.9%) – albeit still the largest deficit since WW-II. However, the deficit beat by just $2bn in 21/22 at $106bn (UBS: $58bn) or 5.0% of GDP (was $108bn or 5.3%). Indeed, the deficit in 24/25 at $57bn or 2.4% of GDP is actually larger than at MYEFO. The materially stronger than expected economy improved the budget position by a cumulative $104bn over 5 years. Surprisingly however, this was almost completely offset by policy decisions (i.e. that deteriorate the budget balance), which provided far more than expected additional fiscal stimulus of $96bn (UBSe: $40bn+) over 5 years; including a significant $18bn or 0.9% of GDP in 21/22 alone. Nominal GDP growth was revised up sharply to 3¾% y/y in 20/21 (was 1%; UBS 3.2%); but grows only 3½% in 21/22 (was 1¼%, UBS 7.3% y/y), as Treasury forecasts assume the iron ore price retraces to their ‘long-run’ estimate of US$55/t FOB by Mar-22 (which we see as conservative). However, budget sensitivities show if the iron ore price remains elevated until Mar-22, it would add ~$7bn to revenue in 22/23. More precisely, each $10/t upside adds $1.3bn, so we estimate if prices remain near the record spot price of ~$230/t ahead, it implies revenue upside of >$20bn/year.

Gross debt lifts to record $1.1tn or 50% of GDP in 24/25; issuance ~unrevised
Australian Government gross debt (at face value) in 21/22 is $28bn lower than in MYEFO, at $963bn or 45.1% of GDP. However, the peak is higher in 24/25 at a record $1,199bn or 50.0% of GDP. Elsewhere, the peak in net debt also increases to a record high in 24/25 of $981bn or 40.9% of GDP. Previously, UBS expected a large ~$75bn downward revision to net issuance, but we now estimate it is likely to be little revised at ~$215bn in 20/21, and ~$140bn in 21/22. Meanwhile, we estimate the broadest measure of total Government debt (market value, across all Governments) will jump to >$2tn or near 90% of GDP in 23/24, the highest ratio since after WW-II.

More fiscal stimulus = RBA taper announcement in July + risk of earlier hike
The budget assumes a further delay to re-opening of the international border until mid-22. But despite this, there’s a virtuous cycle of rounds of much larger than expected fiscal stimulus, resulting in the economy and labour market booming, underpinning a materially better than expected budget ‘starting point’, then allowing for even more fiscal stimulus. Importantly, the Government plans for fiscal consolidation were delayed until unemployment is below the pre-COVID level of 5% (rather than ‘comfortably below 6%’), and deficits are projected for a ~decade. Nonetheless, very low interest rates – supported by the RBA’s 3-year yield target, dovish forward guidance, and QE – means the cost of servicing more debt remains manageable (at least for now). Overall, the Budget will further underpin consumer and business confidence – already around record highs – and poses upside risk to our above-consensus GDP outlook of 5.0% y/y in 2021 and 3.3% in 2022 (albeit the RBA is now ‘top of street’ at 5¼% and 4%). The persistence of stimulus – for several years ahead despite approaching NAIRU – will put upward pressure on wages and inflation. So even with softer US payrolls delaying Fed tapering, the budget means the RBA should be more willing to taper ahead of the Fed, and hence we still expect the RBA will likely announce a taper in July, with QE3 ‘up to $100bn’, and slower purchases until stopping ~end-year; as well as not extending YCC beyond Apr-24. We still expect the RBA to hold the cash rate until end-22, but we now see the risk of an earlier rate hike than the RBA’s forward guidance.

It appears the Morrison plan is to juice the economy such that a looming interest rate shock forces everybody to accept a return of mass immigration to prevent the rate hikes.

Short-term boom followed by another lost decade…

David Llewellyn-Smith
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