Federal budget 2022: Labor’s inflation war falls short

Failure to seriously address the biggest and most pressing problem confronting the economy could have devastating consequences.

The prospect of inflation staying higher for longer also means there is an elevated risk that inflation expectations eventually become unhinged.

Jim Chalmers’s first federal budget on Tuesday fails to seriously address the biggest and most pressing problem confronting the economy: surging inflation.

The policy miss could eventually have devastating consequences for consumers and house prices if the Reserve Bank is forced to keep interest rates higher for longer in 2023 and into 2024.

Despite pre-budget government posturing about dealing with the worst inflation threat facing Australia since the 1980s, the budget papers forecast inflation will now remain above the RBA’s 2 per cent to 3 per cent target band until 2023 to 2024, only returning to target in 2025.

“High inflation is now expected to persist for longer than previously expected largely due to the pass-through of higher energy prices to household bills,” the budget papers said.

While higher interest rates are expected to do the bulk of the hard work needed to cool inflation, the federal budget loomed as a second avenue for doing practical things that might also take excess demand from the economy.

But it has fallen short. The latest delay in bringing inflation back to target raises questions about the wisdom of the RBA’s decision at the start of this month to slow the rate at which it has been tightening the policy screws.

The official cash rate has been raised by 250 basis points since May as the RBA played catch-up with a surprise jump in inflation at the start of the year.

But central bank policy makers stepped back this month, raising the official cash rate by only 25 basis points, not the 50-basis-point increases in prior months.

That decision, prompted in part by growing fears about falling house prices, might soon start to look premature, with inflation proving more stubborn than expected. The prospect of inflation staying higher for longer also means there is an elevated risk that inflation expectations eventually become unhinged.

If those expectations break loose of their foundations, wage growth will spiral and the RBA could face an entirely new war on inflation.

The government forecasts surging expenditure growth and bigger budget deficits over the coming years as it battles to fund increasingly expensive portfolio areas such as healthcare, defence and the cost of rising interest on the mountain of debt over which it now presides.

“Profound and permanent spending pressures on the budget are forecast to grow and grow,” the Treasurer told parliament.

The budget papers describe an environment of extreme and continuing inflation risks.

Chief among them is the prospect of prolonged disruptions in global energy markets as a result of Russia’s war against Ukraine.

Recent flooding across large areas of eastern Australia is also expected to nudge up food prices, while inflation risks are also bubbling up in areas such as rents. National advertised rents rose by 10 per cent in the year to September, with further increases expected.

The government is also assuming retail electricity prices will surge by a further 30 per cent in 2023 to 2024. Electricity and gas prices are expected to directly contribute 0.75 percentage point and 1 percentage point to inflation in 2022-2023 and 2023-2024, respectively.

Globally, inflation numbers have been surprising to the upside of forecasts, putting added pressure on central banks to continue raising interest rates aggressively.

The risk that these global price pressures continue to wash in on Australia’s economy over the coming months remains extreme.