What does the Budget mean for economic growth in 2016-17?

budget_2015-16The Budget was neither hot nor cold. Spending and concessions were funded by savings elsewhere in the Budget. As such it will not massively add to nor detract from growth. The company tax cuts have the potential to lift investment and hiring but will not set the economy on fire. Of more benefit will be the RBA rate cut and the weakness on the Australian dollar that has flowed from it. This is not a bad Budget. It will make a modest contribution to growth in parts of the economy but it is by no means bold and progressive. Perhaps that will wait until after the election.

The Budget and interest rates. The RBA trumped the Budget by reducing the cash rate from 2.00% to 1.75% just prior to the Budget. The Budget forecasts modest economic growth in 2016-17 which all but rules out any rate hikes in the next twelve months. It also leaves the door open for a rate cut if growth appears to be falling short of the targets for 2016-17. With the latest rate cut coming on the heels of weak inflation numbers, the outlook for inflation over the next 18 months will be crucial. While a low cash rate seems certain for the next twelve months, there is also likely to be little movement on longer yields. The US appears to be backing away from multiple rate hikes and may do, at most, two small hikes in 2016 if not less. As such there should be little upward pressure on bond yields.

The Budget and the AUD. The AUD tumbled after the RBA’s rate cut and resumed its decline after the Budget was announced. The extended decline was more likely European reaction to the RBA rather than a negative response to the Budget. The direction of the AUD over the next six months will depend upon interest rate differentials and commodity prices. We expect the AUD/USD to sit around $US 0.74 by December 2016, driven by the expectation of slightly higher interest rates in the United States and some retracement in commodity prices.

We expect the RBA will hold fire for the next few months. The Governor’s Statement provided no future guidance. Given its concerns regarding the global and domestic economies and its expectations for inflation, we expect that the RBA will wait to see what emerges from the data.

A further rate cut remains possible but most likely not at the next meeting. By July, the RBA will have seen new data on the labour market, the national accounts and inflation.