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The budget could push rates higher faster, economists predict

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The RBA’s first rate hike could take the interest rate 0.4 per cent higher on the back of a generous budget cash splash.

“We have overcome the biggest economic shock since the Great Depression. Our recovery leads the world,” Treasurer Josh Frydenberg said on Tuesday evening.

The government’s latest budget has reinforced the improvement in the economy and the labour market, which together underpinned a materially better than expected starting point for the budget.

“Mr Speaker, a strong economy means a stronger budget. This is what we deliver tonight,” Mr Frydenberg told the Senate on Tuesday.

“The largest and fastest improvement to the budget bottom line in over 70 years,” he continued.

The Treasurer’s forecast puts the deficit for 2022‑23 at $78 billion or 3.4 per cent of GDP. Over the next three years, this will more than halve to 1.6 per cent, he said.

Net debt as a share of the economy is expected to peak at 33.1 per cent at 30 June 2026.

On the back of better-than-expected economic recovery, the government revised up its growth forecasts for this financial year from 3.75 per cent to 4.25 per cent.

Commenting on the government’s pre-election cash splash, AMP’s Shane Oliver and Diana Mousina said they were not surprised with the lack of direct losers given the document’s timing.

Flagging low- and middle-income taxpayers, welfare recipients, motorists, first home buyers, parents with young children, older super members, apprentices, builders, small business owners, defence industries, transport users and tourism operators as budget winners, Dr Oliver and Ms Mousina pinpointed “two big risks” flowing from the budget at the macro level.

“First, the pre-election cash splash risks overstimulating the economy at a time when it is already strong, further adding to inflationary pressures and adding to the amount by which the RBA will have to hike interest rates,” according to Dr Oliver and Ms Mousina.

“Second, the reliance on growing the economy to reduce the budget deficit and debt is unlikely to reduce debt quickly enough and is dependent on interest rates remaining low relative to economic growth. Ten-year bond yields have already gone up more than fourfold since their 2020 low warning of a sharp increase in debt interest payments beyond the medium term,” they continued.

According to AMP’s projections, economic growth is unlikely to be anywhere near strong enough to reduce the debt burden like it did in the post-WW2 period unless there is another immigration boom or 1980s style focus on boosting productivity – both of which the pair termed “unlikely”.

“At some point tough decisions are likely to be required either to reduce spending as a share of GDP or raise taxes,” the experts said.

As for implications for the Reserve Bank of Australia, Dr Oliver and Ms Mousina said they expect the first rate hike in June and the cash rate to reach 0.75 per cent by year end, before climbing to 1.5 next year.

“The extra stimulus in the budget increases the chance that the first rate hike is 0.4 per cent rather than 0.15 per cent, with the cash rate reaching 1 per cent by year-end.”

UBS economists also believe the near-term fiscal stimulus reiterates the case for RBA rate hikes.

“We see a stronger case for ‘early’ hikes compared to their forward guidance, and likely to start in June,” the investment bank’s analysts said post budget.