Solid economic outlook bodes well for Australians who own shares and property

Treasurer Josh Frydenberg has released an upbeat mid-year budget update, despite the fast-spreading Omicron Covid-19 variant. Picture: Gary Ramage/NCA NewsWire

If Josh Frydenberg is right about the two to three-year outlook, then those holding Australian shares are going to prosper. And those who have paid high ­prices for real estate can relax – there may be more to come.

The Treasurer’s projected economy is one where we achieve growth but inflation does not get out of hand. Profits surge and unemployment falls – labour short­ages are overcome by increased migration. That means interest rates stay low, preserving the asset price rises we have seen and very probably taking them even further. It’s a perfect scenario.

There are a series of risks but I think what is happening in the US is the greatest of all. There are indications in the statement that Frydenberg has a similar view.

In the mid-year statement, the first number that caught my eye was the explosion in corporate profits, as reflected in tax revenue.

In the May budget, the government expected tax revenue to be $82bn in 2021-22. That has risen by 21.9 per cent to $100bn.

And over the next four years profits are expected to rise a total of $36.8bn. Those profits and the franking credits they generate will underwrite the sharemarket. They also trigger an 8 per cent rise in both mining and non mining investment in 2022-23 but housing investment, after rising 6 per cent this year, is set to fall by 2 per cent in 2022-23.

The government expects growth in China to be maintained at about 5 per cent, which will hold mineral revenue. The increase in consumer income will boost retailers and, of course, banks.

Enterprises are struggling with labour shortages, but the government expects the 2021-22 wage rise to average only 2.25 per cent and, while that will edge up to 2.75 per cent in 2022-23, that is not enough to explode interest rates.

Indeed, although the expected CPI index rise has been lifted from the 1.75 per cent forecast in May to 2.75 per cent for 2021-22, Treasury expects the CPI rise to slip back to 2.5 per cent in 2022-23. These are the sort of figures the Reserve Bank is working on to forecast a continuation of low interest rates. Many will challenge these forecasts, which are in stark contrast to what people are experiencing, but Frydenberg is staking his reputation on them.

What can go wrong? Obviously, we may see a much greater wages breakout than the government forecasts, or the new Omicron version of Covid-19 may hit the economy much harder than is presently projected.

Frydenberg is relying on high vaccination rates to protect against the virus without dramatic clamps.

Another danger is the war clouds in Ukraine and Taiwan and a worsening situation in Iran. Clearly, if any of those sensitive world areas were to trigger armed conflict, it would affect markets – particularly Taiwan.

But the greatest risk of all, in my view, is what is happening in the US. And to be fair, Frydenberg devotes considerable space in the budget to provide an update to the US situation.

We are watching US Federal Reserve chair Jerome Powell undertaking a high-risk experiment. US inflation is now approaching 7 per cent and there are signs in producer pricing that inflation is headed into double figures. Once high inflation becomes embedded in an economy, it develops its own momentum.

Many around the world believe the Fed should have tackled the issue much earlier. Currently the official interest rate is close to zero so we are looking at negative ­interest rates in the US of around 7 per cent.

Powell has promised to lift ­official interest rates three times next year, but that would still leave the actual rate at less than 1 per cent. That means the buying power of the US dollar is still falling at an annual rate of about 6 per cent, assuming there is no decline in inflation.

There must be a point at which this is not sustainable, and history tells us that tackling inflation late is incredibly painful because it ­requires high interest rates that damage the economy. And because US markets have such a big impact on the globe, most nations would be hit by a sharp US downturn.

The government statement does not forecast a steep US downturn next year, but it is fascinating that in the forward projections it expects the 2023 US growth rate to slump from 4.25 per cent to 2.25 per cent. If that is all that happens, the world would have dodged a bullet.

But the Australian government’s prediction of a sharp fall in US growth rates shows that it is concerned about what is happening. Meanwhile, Scott Morrison and Frydenberg are taking a strong local economy to the election next year.