Could the Federal Budget drive an RBA rate rise?

When it comes to the RBA and the Federal Government, it’s really a tale of two cities.

The RBA needs us to cut spending, unemployment to rise, and the market to become highly competitive such that wage growth doesn't fuel more inflation. It’s the story of taking individual pain for the greater good.

On the flip side, the Federal Government is under pressure to lift a weak economy and support a population where many are feeling severe strain. There is also a Federal Election due in the next 12 months. Starting to see how these conflicting desires could cause problems?

It was clear to many that while the RBA announced a hold on rates, it was this week's Budget could be the game-changer – too generous and the RBA would have to hike again, too miserly and we might see a cut (and genuine outrage from Australian citizens).

Now it’s here, we ask what it all means for you.

In this wire, I’ll give you a quick summary of what the Budget told us about the economy, some of the key measures and, with the help of VanEck’s Head of Investments and Capital Markets Russel Chesler, consider what these might mean for investments, and answer that big question – is the Budget going to trigger another rate hike?

Highlights

(This list is obviously not conclusive and just picks out a few interesting measures with implications for the economy or for investors).

• Phase 3 tax cuts: we already knew this was coming. Millions of Australians will see a jump in their take-home salaries next year and this could boost spending (or simply help them break even…)
• The $300 energy rebate for all households and $325 for some small businesses: Power bills have been at a crunch point for some time, after all, energy supply challenges were one of the drivers of global inflation. The Government argues this will reduce headline inflation by 0.5% in 2024/2025, though you could also argue that it doesn’t actually reduce energy prices, simply adds purchasing power to a household instead – especially noting it is universally applied, not only applicable to households under certain thresholds.
• Increase to the Commonwealth Rent Assistance by 10%
• Additional $3 billion in healthcare funding to put a one-year freeze on the max PBS patient co-payment and a five-year freeze for pensioners and other concession cardholders.
• Adjustments to the Higher Education Loan Program (HELP) and other student debt: indexation will now be capped to the lower of the CPI or the Wage Price Index and backdate relief to accounts that existed on 1 June 2023.
• Housing initiatives: An expansion of the existing program with some key measures including support connecting essential services to new housing, boosting the Commonwealth Rent Assistance by 10%, supporting universities in increasing the supply of student housing, double funding for homelessness services and increasing housing for women and children experiencing domestic violence.
• A $22.7bn Future Made in Australia package: to support industries that contribute to the net zero transformation. It also delivers a 10-year extension of funding to the Australian Renewable Energy Agency and the $44.4 million Energy Industry Jobs Plan, plus $134.2 million for skills and employment support. Be aware of the additional investment in supporting the resources sector with geological mapping, speedier processing and support on offer – mining will still be an Australian focus from a renewables perspective.
• Infrastructure investment to $16.5 billion over 10 years: including a focus on better transport for Western Sydney, better infrastructure to service South East Queensland and $101.9 million package to upgrade regional airports and remote airstrips, plus $40 million to support the roll-out of additional wi-fi in remote and regional Australia.
• Partnership to build the world’s first commercial-scale quantum computer in Brisbane: along with funding for Landsat Next satellite program, Australia’s Digital ID System and a National Robotics Strategy. (I note that many readers may wonder why I’d highlight this, but this reflects next-level tech trends investors should be watching. Love AI? Quantum computing is a game changer…)

What you need to know about the economy based on last night’s Budget

The Budget didn’t paint a particularly pretty picture of the economy. Weak is the word. But as Chesler points out, it shouldn’t come as a surprise to anyone.

To quote from the Budget:

“Household consumption was flat over the past year, as people have responded to the cost-of-living pressure by pulling back on discretionary spending to make room for essentials. Higher interest rates and elevated construction costs are weighing on the demand for new housing, with dwelling investment expected to contract further in 2023-2024.” Budget Paper No. 1, Budget 2024-25

It also noted a softening in the labour market and the expectation for the unemployment rate to rise to 4.5% by the June quarter of 2025.

“Growth is expected to remain subdued over the forecast period. Real GDP is forecast to grow by 2% in 2024-25 and 2.25% in 2025-26.” Budget Paper No. 1, Budget 2024-25

One highlight was that business investment grew at 8.3% last year and is tipped to continue through to 2025-26.

The Government is predicting the cash rate to ease to 3.6% by mid-2026 and expects inflation to fall to 2.75% for the 2024-25 year – lower than the RBA’s forecasted 3.1%. But Chesler doesn't agree with this rosy forecast.

“We do not expect inflation to fall back into the RBA range of 2% to 3% this year. There are no signs of low unemployment changing. The latest numbers from the ANZ-Indeed job ads show a 2.8% increase in April, which is 36.5% higher than pre-pandemic levels. 

Strong labour demand is pushing up private sector wages, and we don’t expect wage growth to fall from its current level of 4.2%. Services inflation driven by wage and rent growth will not fall,” says Chesler.

While this budget has delivered a surplus, the Government expect to shift to a deficit in the following years.

AMP Chief Economist Shane Oliver discussed this part of the Budget in this wire this morning, pointing out that:

“Due to new spending and structural pressures from interest costs, the NDIS, defence, health and aged care spending as a share of GDP is expected to average 26.2% over the longer term, well above the pre-COVID average of 24.8%. Despite a blip down with tax cuts, revenue trends up reaching its 1986-87 record of 26.2% of GDP in 10 years. So bracket creep, not spending restraint is assumed to do the work in getting us back to a budget balance.”

What do these measures mean to the RBA?

You could argue that some of the Government’s policies effectively kick the can down the road for the RBA.

As Morgan Stanley Research has already noted:

“For the RBA, subsidies will lower its 2024 headline inflation forecast to the top of its target but also will raise its 2025 forecast. While a re-acceleration in underlying inflation could bring rate hikes on the table, we think a longer period on hold is more likely.”

Westpac Economics pointed out that new spending on infrastructure and housing is stimulatory, despite measures like rental assistance or energy rebates being designed to lower inflation.

Chesler is concerned that the measures designed to lower inflation will have the reverse effect.

“To my mind, the Budget has increased the likelihood the next rate change will be up rather than down,” says Chesler.

He points out that tax cuts and an energy rebate – noting that the rebate is available to all households regardless of income – simply give people greater ability to spend on things other than energy or tax and may drive people to switch their spending back to consumer discretionary products again.

Some factors for investors to think about based on the Budget

Many fund managers have said they like to ‘follow the money’, or in other words, watch where governments and institutions are putting money and invest in supporting industries and sectors.

Some key areas of spend include:

• Housing
• Infrastructure
• Green transition
• Technology

The green energy sector – with funds dedicated to infrastructure, green businesses and mining is one clear beneficiary of the budget, but it isn’t the only one.

Tech buffs might keep a keen eye on the Government’s nominated spend on projects like quantum computing, robotics and the digital ID. While Australia’s industry on this front is only nascent, the spending should be supportive of growth. Alternatively, it’s a good indication of what might be important in the longer term, even if you have to look internationally to find solid investments.

In its Initial Reaction to the 2024-25 Budget, Macquarie analysts argued that tax cuts and the surprise energy rebate could be a positive catalyst for retail stocks (more money in your pocket…). Its preferred exposures include Coles (ASX: COL), Endeavour Group (ASX: EDV), Flight Centre (ASX: FLT), Nick Scali (ASX: NCK), Temple and Webster (ASX: TPW) and Woolworths (ASX: WOW).

Chesler shares Macquarie’s positive view on the consumer discretionary sector, noting, “The Budget is an overall positive for equity markets, with a lot of liquidity coming in.”

He sees key opportunities for mining companies and the building sector.

“With considerable support for critical minerals and hydrogen in the Budget, mining companies like Fortescue (ASX: FMG), Mineral Resources (ASX: MIN), Wesfarmers (ASX: WES), IGO (ASX: IGO) and Liontown (ASX: LTR) should benefit. The building sector will obviously benefit from the considerable housing and infrastructure spending. It is a positive for companies like Brickworks (ASX: BKW) and Reece (ASX: REH),” Chesler says.

As part of this, he also sees benefits to A-REITs.

On the flip side, Chesler expects the education sector to be hard hit by the Budget – visa cuts will hurt the returns from international students.

From a fixed income perspective, Chesler also sees the Budget as a negative for fixed-rate bonds, suggesting that investors focus on floating-rate products instead.

A final word

In all, you don’t need to think about dramatic changes for your investments, though there are certainly some interesting ideas you can take from it. As Chesler points out, accompanied by others in the industry, the takeouts on the economy were hardly a surprise.

However, investors should keep watching inflation. After all, that’s the key to the RBA and its rate decisions – and that will influence markets too.