Last week delivered a relatively uninspiring Federal budget, but some modestly good news on inflation with the release of the February monthly CPI figures.
An improving trend for inflation follows the news earlier in the month that economic growth improved in the final quarter of 2024. With the RBA recently kicking off what is likely to be a modest easing cycle this year, the economy looks set for at least a modest cyclical improvement over the coming year, following a period of below average growth.
While the cyclical outlook for the economy appears to be brightening a little, the Federal government’s fiscal position is characterised by a number of significant vulnerabilities that are likely to constrain Australia’s potential over the medium to longer-term unless they are addressed.
Government Spending Looks Too Big Relative to the Economy
Federal government spending as a share of GDP appears to have settled at a level that is well above pre-pandemic levels.
The government likes to date the improvement in budget finances from the starting point of the Covid budget blow-out. This, however, is a misleading benchmark. Spending has clearly undergone a step change from pre-Covid levels, with no plans to rein it back in.
Due to structural pressures from a range of significant expense areas - including interest costs, the NDIS, defence, health and aged care - Federal government spending as a share of GDP is expected to continue to average close to 27% over the longer term. This is well above the pre-Covid average of 24-25%.
The quoted deficits for FY25 and FY26 at ~1% of GDP don’t look too worrying at face value. However, the fiscal position needs to be assessed from the perspective of spending (and revenue) as a percentage of GDP, not just the budget balance.
The government is benefiting from significant extra revenue flows, coming from higher personal tax due to stronger jobs growth and resilient commodity prices (higher corporate tax).
However, this is more good luck than good management, contrary to what the government argues.
This fortuitous windfall on the revenue side is what drove the surpluses in 2022-23 and 2023-24. The government claim that it has “banked” most of the windfall gains in recent years once again relies on benchmarking against the “fiscally abnormal” Covid “shutdown” period.
The more recent fiscal windfall situation can be seen in figure 3. “Parameter changes” are estimated to aid the deficit over the five years to 2028-29 by $36.4bn. However, the table also shows virtually all of this windfall (the “new stimulus” line) is being spent. The new stimulus totals $34.9bn over five years, basically equal to the assumed windfall gains.
The deficit is assumed to eventually return to balance (albeit not for another 10 years). However, even then it is largely bracket creep, not spending restraint, that is driving the budget back into “assumed” balance.
| FY25 | FY26 | FY27 | FY28 | FY29 | |
| FY25 Budget $bn | -28.3 | -42.8 | -26.7 | -24.3 | |
| Dec 2024 MYEFO $bn | -26.9 | -46.9 | -38.4 | -31.7 | -37.2 |
| Parameter changes $bn | 0.5 | 12 | 10.3 | 5.1 | 9.5 |
| New Stimulus $bn | -0.1 | -7.2 | -7.7 | -10.7 | -9.2 |
| FY26 Projected Budget $bn | -27.6 | -42.1 | -35.7 | -37.2 | -36.9 |
| % GDP | -1 | -1.5 | -1.2 | -1.2 | -1.1 |
Source: Treasury Budget Papers.
Cook(ed) Books
Another key issue in addition to the reliance on windfall gains to keep the deficit in check is the use of “off-budget” accounting to mask a large amount of government spending. This is not a new practice, but it does appear to be getting worse.
While the cash budget position has slipped to a “moderate” deficit, broader measures of the Australian government budget position show a deficit that is materially larger than the number highlighted on budget night.
The broader “headline” deficit includes “Specialist Investment Vehicles” which invest in projects that deliver “public value” and a “financial return” to taxpayers. For example, Clean Energy Finance Corporation loans and equity investments in areas like the NBN impact the headline cash balance but not the underlying cash balance. The cost of recent HECs concessions have also been positioned off balance sheet. As a result, the differences between the underlying and headline cash balance estimates have been expanding. Accounting for “off-budget” spending, a headline cash deficit of $65.2 billion (2.3 per cent of GDP) is estimated in 2025–26, compared to the quoted deficit of $42.1bn.
Indeed, over the five years to 2028-29, the cumulative “cash” deficit is forecast to be $179.5 billion. The government’s finances are much deeper in the red once so-called “off budget” spending is included, resulting in a cumulative headline deficit of $283 billion - a discrepancy of just over $100bn dollars!
This actual headline fiscal position accords much more closely with the strong rise in federal government debt in recent years.
As we discussed previously, structurally bigger government risks crowd out private investment and slow productivity growth, as well as potentially make the economy, our bond market and currency vulnerable if we do indeed see a negative revenue shock somewhere down the track.
Productivity drought
Apart from the general shift to stubbornly large government spending, there appeared to be little in the budget to improve Australia’s poor productivity performance. From a productivity perspective, the economy needs reform in terms of the tax system but also competition and industrial relations, as well as better constructed energy policy. The three-year election cycle doesn’t seem to lend itself to much time and thought for genuine structural reform. Not surprisingly, last week’s budget was framed with election sweeteners as its centrepiece. However, the previous two budgets also contained little in terms of genuine reform.
Housing woes
There were once gain some modest incremental announcements to encourage new housing builds, but this is unlikely to be enough to hit the government’s 2 million new homes target over the next five years. This plan is estimated to cost a committed total of $21 billion, inclusive of $4.5 billion given to states and territories to address current infrastructure backlogs and issues surrounding the delivery of new homes. The current building approvals trend suggests the government is likely to fall well short of target (figure 4).
Net migration missing government targets
Adding to housing pressure, the government has not as yet been able bring down net overseas migration to its target levels. Admittedly there are many elements to migration that are out of the government's control, including the pace of departures, the take up of visas issued, and movements of New Zealanders. However, net migration has continued to exceed the government’s earlier forecasts by a large margin. Over the year to June 2024, net migration was 40,000 stronger than the Government's previous forecast, while the forecast for the current financial year has been revised up by 75,000. The issue of very strong net migration and the impact on housing will not be going away anytime soon.
Inflation Trend Looking Better
While the budget didn’t bring much good news for the economy’s long-term prospects, last week’s monthly inflation numbers were at least marginally encouraging. The monthly CPI indicator in Feb-25 ticked down to 2.4% y/y, a touch below consensus (2.5%). The trimmed mean measure - a gauge of core inflation - rose to a 2.7% annual figure in February, slowing from 2.8% in January, but still staying around the level where it has been for the past three months. The RBA's latest (Feb-25) Q1 forecast for the trimmed mean was 2.9% y/y so this is at least, at face value, a positive result.
“Core” inflation has been weighted far more heavily in the RBA's reaction function recently, given the material downward impact on headline CPI from subsidies. However, it is the quarterly CPI that will remain the key driver for the RBA’s reaction function. The Q1 CPI is due on 30 April, ahead of the RBA’s 30 May board meeting. Another two labour market prints are also due ahead of the RBA’s May meeting.
The February report provided updates on many services for the quarter where inflationary pressures continued to ease. Prices for restaurant meals and takeaway food grew 2.8% and 2.5% respectively, back in the target band of 2-3%. Insurance costs were still running at an elevated 7.9% from a year ago, but that was the lowest in two years and has halved since April last year. There is still a significant number of services to be measured in March, especially in the health group.
While trends are somewhat promising, we do note that last year’s Q1 inflation did surprise to the upside. Last year consensus expected headline CPI in Q1-24 to rise by 0.8% q/q, but the outcome came in above expectations at 1.0% q/q. Indeed, there has been a tendency for the quarterly number to come in above the monthly lead in numbers in Q1 in recent years.
While there is still some “statistical” risk around Q1 inflation, it does appear to be trending lower. Lower inflation helps the case for lower rates and a cyclical turning point for the economy. Our base case is for Q1 CPI to be good enough for the RBA to cut again in May, followed by another cut in the second half of the year. Because of the Q1 measurement quirks discussed, however, it may be a close call
Inflation, the budget and interest rates
The cost-of-living measures extended in the budget (e.g. electricity rebates) are clearly helping reduced measured headline inflation. As discussed, however, the RBA will be more focused on the core rate. More broadly, the significant new stimulus, which shifts the budget from surplus to deficit and the 5.5% y/ y. projected growth in Federal spending to 2028-29, will boost demand in the economy. All of this makes the RBA’s job harder. While we don’t think it precludes more rate cuts, it does mean rates will likely be higher than would otherwise have been the case.
In summary, the local economy looks to be set for at least a moderately better period of growth due to a combination of fiscal stimulus, lower inflation, rising real wages, and lower interest rates. However, it is likely to be a relatively modest cyclical recovery back to “trend” growth. This, of course, relies on the assumption that our recovery is not knocked off course by an adverse global shock. However, from Australia’s perspective, a more robust and sustainable growth trajectory will likely require a better conceived, productivity-focused policy platform.
Written by
David Cassidy, Head of Investment Strategy
David is one of Australia’s leading investment strategists.
About Wilsons Advisory: Wilsons Advisory is a financial advisory firm focused on delivering strategic and investment advice for people with ambition – whether they be a private investor, corporate, fund manager or global institution. Its client-first, whole of firm approach allows Wilsons Advisory to partner with clients for the long-term and provide the wide range of financial and advisory services they may require throughout their financial future. Wilsons Advisory is staff-owned and has offices across Australia.
Disclaimer: This communication has been prepared by Wilsons Advisory and Stockbroking Limited (ACN 010 529 665; AFSL 238375) and/or Wilsons Corporate Finance Limited (ACN 057 547 323; AFSL 238383) (collectively “Wilsons Advisory”). It is being supplied to you solely for your information and no action should be taken on the basis of or in reliance on this communication. To the extent that any information prepared by Wilsons Advisory contains a financial product advice, it is general advice only and has been prepared by Wilsons Advisory without reference to your objectives, financial situation or needs. You should consider the appropriateness of the advice in light of your own objectives, financial situation and needs before following or relying on the advice. You should also obtain a copy of, and consider, any relevant disclosure document before making any decision to acquire or dispose of a financial product. Wilsons Advisory's Financial Services Guide is available at wilsonsadvisory.com.au/disclosures.
All investments carry risk. Different investment strategies can carry different levels of risk, depending on the assets that make up that strategy. The value of investments and the level of returns will vary. Future returns may differ from past returns and past performance is not a reliable guide to future performance. On that basis, any advice should not be relied on to make any investment decisions without first consulting with your financial adviser. If you do not currently have an adviser, please contact us and we would be happy to connect you with a Wilsons Advisory representative.
To the extent that any specific documents or products are referred to, please also ensure that you obtain the relevant disclosure documents such as Product Disclosure Statement(s), Prospectus(es) and Investment Program(s) before considering any related investments.
Wilsons Advisory and their associates may have received and may continue to receive fees from any company or companies referred to in this communication (the “Companies”) in relation to corporate advisory, underwriting or other professional investment services. Please see relevant Wilsons Advisory disclosures at www.wilsonsadvisory.com.au/disclosures.