An inflationary budget?

From Challenger Chief Economist Dr Jonathan Kearns

An inflationary budget?

The Budget combines $10 billion of increased spending over the next year with the pre-announced Stage 3 tax cuts, and yet projects a sharp fall in inflation over the next 12 months. Can it produce that magical combination?

Receipts are little changed from last year’s budget. And most of the additional spending in the next couple of years is accounted for by the ‘cost-of-living’ measures.

The cost-of-living subsidies and relief measures will reduce measured inflation. The Treasurer noted that measures in last year’s and this year’s Budgets reduce inflation over the year to June 2024 by 0.75% points and for the year to June 2025 by 0.5% point.

However, these measures add to household incomes, particularly of households that will spend a large share of that additional income, and so will contribute to extra spending.

Further, temporary cost-of-living relief measures (such as the energy rebate) simply move inflation, pushing it to later years, in particular when the rebate rolls off from July 2025.

Despite this, through the miracle of timing (showing June quarter data), rounding and some other noise, the Budget forecasts don’t show a bounce back in inflation.

The RBA frequently notes that it ‘looks through’ temporary supply-driven inflation shocks, and by that logic it should not be guided by temporarily lower measured inflation. The inflation dragon still lurks in our future.

If anything, the Budget adds to, rather than reducing, the excess of demand relative to supply in the economy which is driving persistent inflation and is of concern to the RBA. It’s not clear that the RBA can respond to lower measured inflation with lower interest rates when the underlying demand-supply imbalance remains.