Budget may push out rate cuts even though wages growth peaks

By the end of the week economists could be conceding rate cuts for 2024 are off the table, especially if labour force figures on Thursday come in stronger than expected.

Prime Minister, Anthony Albanese and Federal Treasurer Jim Chalmers arrive for Question Time at Parliament House in Canberra. Picture: NCA NewsWire / Martin Ollman

Cost-of-living relief is cold comfort for struggling mortgagees as an expansionary Federal Budget will only increase the RBA’s reluctance to cut interest rates even as wages growth may have peaked.

Australia’s wage price inflation slipped to 4.1 per cent in the March quarter, consistent with the RBA’s emerging view that “wages growth appears to be around its peak for the current cycle”.

However the jobs market remains tight with unemployment well below levels consistent with stable prices. Cost-of-living increases will again be front and centre for annual wage negotiations.

The wages data pushed back against recent market speculation of another interest rate hike.

Market pricing now implies no chance of another rate hike. Helped by the unchanged interest rate guidance from the Reserve Bank this month, the chance of another rate hike fell from a peak near 80 per cent chance after higher than expected March quarter inflation data at the end of April.

However, many economists including those of the big four banks still say that rate cuts will get underway in November. After a surprisingly-expansionary Federal Budget, they may have a low tolerance for any further signs of higher than expected inflation and economic growth.

The Government expects its subsidies affecting rental, energy and pharmaceutical prices to lower headline CPI inflation by 0.5 per cent over the 12 months to June 2025.

It has forecast annual headline inflation of 2.75 per cent by the June quarter of next year - back inside the 2-3 per cent target band and well below the RBA’s forecast last week of 3.2 per cent.

However the central bank is expected to look through such temporary effects on prices.

Consensus on the timing of the first interest rate cut could easily shift to the March quarter of 2025.

Market pricing implies interest rates won’t be cut until the second half of 2025 – that is what the RBA assumed in its latest forecasts that inflation will slowly fall to the middle of its target band by the end of 2026.

Australian jobs data for May are due on Thursday with economists expecting the unemployment rate to tick up to 3.9 per cent on the back of a 24,000 rise in jobs.

Economists also point out that 4 per cent wages growth is only consistent with the inflation target if productivity is running at least 1 per cent on a sustained basis. Despite some improvement in productivity in recent quarters after a particularly weak period, it remains negative in annual terms.

“We expect the RBA to continue to sit on the sidelines and watch labour market developments closely and the expansionary nature of last night’s Federal Budget will also keep it cautious and patient,” said Su-Lin Ong, chief economist at Royal Bank of Canada.

Moreover any relief about the slightly slower than expected wage growth during the March quarter will only partly offset some of the new inflationary concerns arising from the Federal Budget.

“Assuming a further gradual easing in labour market tightness, there’s a good chance wage inflation has peaked and could ease further over the coming year. However, we now have a new injection of policy stimulus from the Budget to contend with,” said Betashares chief economist, David Bassanese.

He said the main thrust of the Budget was a “neat trick” of price subsidies to provide cost-of-living support to households while also helping to directly lower measured CPI inflation.

“It’s a far better policy than merely giving households a fistful of dollars – as we’d get the income boost without the price-lowering effect of subsidies,” Bassanese said.

He warns that direct effect of the Budget in mechanically lowering inflation doesn’t allow for indirect effects on inflation such as higher private sector rents and more cash in household pockets.

“What matters for the interest rate outlook is not headline CPI inflation which can be manipulated through policy sleight of hand in certain key areas such as housing but broader price pressures as captured by the trimmed-mean measure of inflation,” he added.

The latter will be driven by the broader balance between supply and demand in the economy.

Here, the RBA will find it hard not to conclude that the Budget has worsened this balance.

“Indeed, the overall Budget is surprisingly expansionist given the inflation,” Bassanese said.

“Given the inflation-lowering effects of the cost-of-living support measures, the Treasurer perhaps felt emboldened to spend up in other areas – hoping the RBA would not mind too much.”

On the economic outlook, a clear upside risks now surrounds consumer spending.

Perhaps optimistically, real household disposable income is forecast to rise by a solid 3.5 per cent over the coming financial year, yet real consumer spending is only expected to rise 2 per cent.

“The Government is counting on much of the lift in household income being saved not spent, but if households decide instead to lift spending in a meaningful way, not only are rate cuts unlikely anytime soon there would be a very real risk of higher interest rates,” Bassanese warned.

He now sees a 40 per cent chance of a rate hike before the federal election.

But the stimulatory federal budget is a modest positive for stocks, with the key beneficiaries to be companies exposed to low-income consumers, UBS strategist Richard Schellbach said.

“Equity market earning, and stock prices, are both nominally measured, and hence the inflationary elements of the budget are a tailwind to equities.

Broad-based tax cuts, plus the targeted measures to help battling households, will support retail spend over coming quarters, and somewhat reduce any near-term fears of a consumer collapse.”

Macquarie Equities strategist Matthew Brooks saw it as a “pre-election Budget” that should help the retail sector. With well over 50 countries holding elections in 2024, he also favours resources stocks for exposure to a cyclical upturn and a hedge against the potential for a further rise in bond yields.

Originally published as Budget may push out rate cuts even though wages growth peaks