This time last week we wrote about the themes we thought would be in the 2017-18 Federal Budget. It was not a hard task because many of the changes proposed in the Budget were extensively canvassed and leaked beforehand. There were some last-minute surprises mostly relating to proposed tax increases, the 0.5 percentage point lift in the Medicare Levy from 1st July 2018 and the new levy to be imposed on the biggest banks. All told, the Budget is a big spending, big taxing affair that in an overall economic sense means that net Government spending will be adding relatively little more to spending in the economy over the next year or so than was proposed in the Budget bought down the year before.
Where this lack of addition to net government spending becomes evident is that a year ago the Budget forecast an underlying deficit of $26.1 billion in 2017-18, revised in the December 2016 Mid-Year Economic and Financial Outlook to $28.7 billion and in the Budget last week the forecast 2017-18 underlying deficit is $29.4 billion. Allowing for all of the announcements in the Budget the net effect on the underlying budget deficit in 2017-18 is a $700 million lift in the underlying Budget deficit compared with the December 2016 revised forecast, the equivalent of well under 0.1 percentage point of annual GDP.
The negligible stimulatory impact from the Budget will matter little if the economy is showing signs of growing at its potential growth rate (around 2.8%) or better over the next year or two. Treasury’s economic forecasts point to sub-potential real GDP growth of 1.75% in the current 2016-17 financial year accelerating to 2.75% in 2017-18 and 3.00% the year beyond. Within these ostensibly comforting growth forecasts pointing to steady acceleration are some important and potentially contentious component forecasts. Housing investment spending decelerates in 2017-18, but does not fall until 2018-19. Real household consumption spending accelerates from 2.5% in 2016-17, to 2.75% in 2017-18 and 3.00% in 2018-19. Also, non-mining investment spending by businesses lifts sharply from 1.5% in 2016-17 to 4.5% in 2017-18.
Broadly speaking Treasury’s economic forecasts assume that negative contribution to GDP growth will be confined to housing activity and that starting more than a year away when the proposed lift in Government infrastructure spending is starting to accelerate. The Government announced several big additions to its infrastructure spending plans in the Budget, but there is a delay before major spending starts to kick -in, starting in 2017-18 and ramping up beyond.
One potential problem is that home building activity rather than growing slowly in 2017-18 actually starts to fall in that year, effectively a year earlier than forecast by Treasury. There is some evidence that this earlier-than-expected fall in housing activity could occur. Home building approvals are falling sharply, down almost 20% y-o-y on the latest data for March. Reports are increasing of residential property developers experiencing financial difficulties. Also the Budget announced a mixed bag of measures for housing and some relating to residential property investors, especially foreign investors in Australian residential property could be just enough to tip demand showing already the first signs of vulnerability.
If housing tops out and starts to fall earlier than expected it will also be very hard to see household consumption spending accelerate the way Treasury is forecasting in 2017-18. Persistently very weak wages growth (a phenomenon that both Treasury and the RBA are finding hard to understand fully) combined with exceptionally high household debt outstanding appear to be causing households to try and balance their budgets by crimping on retail spending. Real retail spending fell by 0.1% in Q1, a very weak result and one that seems to indicate that it may be very hard for annual growth in household consumption to make Treasury’s forecast of 2.5% in 2016-17 making it that much harder to achieve 2.75% in 2017-18.
There is an increasing likelihood that untoward weakness in housing activity and household consumption spending set in well before the cavalry charge from greater Federal government infrastructure spending becomes evident in 2018-19. The uncertainty about the outlook for housing and household consumption spending make the interest rate outlook uncertain too. If housing activity starts to fall in 2017-18 rather than 2018-19 it is possible that the next rate move by the RBA could be a cut rather than a hike, although probably not until late this year or early in 2018. If housing somehow stays stronger than expected for longer and still firm housing activity coincides with the ramp up in infrastructure spending beyond 2017-18 then a quite pronounced cash rate hiking cycle could lay in store. We are starting to consider that a weaker rather than a stronger outlook lies in store, but want to see a few more months of data before changing our rate call that the next rate move is a hike, probably early in 2018.