Australian Economy

Why there are economic headaches ahead for the winner

Across the Atlantic, United Kingdom inflation hit a 40-year high of 9 per cent and consumer confidence fell to minus 40 – the worst since records began in 1974.

Meanwhile, China’s economic slowdown is worse than feared. After locking down Shanghai for weeks, President Xi Jinping’s COVID-19 clampdown is spilling out to global supply chains, delaying the delivery of manufactured goods and pushing up prices around the world.

Construction pain

China’s problems could be starting to become Australia’s – notably in an over-stimulated housing construction industry, which has been artificially boosted by the $2.5 billion HomeBuilder program rolled out during the pandemic.

Local builders, who locked in fixed-price home contracts, are facing surging costs for imported materials such as timber and steel, putting companies such as Metricon Homes under financial strain.

The sector is also one of the most exposed to the prospect of interest-rate-driven house price falls, and the Reserve Bank of Australia is expected to implement a string of interest rate rises in the foreseeable future.

Market economists expect house prices to fall by between 10 per cent and 15 per cent over the next 18 months, and some of the more bearish analysts are tipping larger falls of up to 25 per cent.

Higher rates

Ending emergency-era interest rates is a positive development. The domestic economy is currently red-hot, as evidenced in official data this week, which showed the jobless rate falling to 3.9 per cent in March and remaining there in April. There are almost 401,000 more people in employment than at the start of the pandemic, and women make up 60 per cent of the newly employed.

The massive $337 billion federal government stimulus, near-zero interest rates and state government spending have delivered a jobs boom. The labour market is close to full employment and the economy is running near capacity.

Businesses are now complaining about a shortage of skilled workers and crying out for more foreign workers to be given visas, although the Coalition and Labor are not saying much about immigration during an election.

The huge stimulus injection that has left the balance sheets of households and businesses flush with cash is colliding with supply chain bottlenecks. Too much money is chasing too few goods. Demand-supply imbalances have been exacerbated by the global energy price crunch from Russia’s invasion of Ukraine.

Household costs rising

The spike in the price of oil, gas and coal has delivered a national income boost via Australia’s commodity exporters. But that windfall comes at the expense of higher fuel and food costs for households.

Headline inflation of 5.1 per cent is tipped by the RBA to hit 5.9 per cent late this year. The central bank’s preferred underlying inflation measure – which strips out major price movements such as for fuel and food – is expected to remain above its 2-3 per cent target band until mid-2024.

Wages are failing to keep pace, as evidenced by the modest 2.4 per cent wage growth reported this week, which was leapt on by Labor as proof that people were “going backwards”.

Richardson says: “Amid what are the strongest economic conditions in 50 years, there are a whole lot of punters hurting because inflation is reducing their purchasing power, wages have barely budged and interest rates are going up.”

Markets are betting that the RBA’s 0.35 per cent cash rate will surge to 2.6 per cent by December. That would mean a rise of more than 0.25 of a percentage point each month for the rest of the year.

Most market economists forecast a slightly lower rise in the cash rate – to just less than 2 per cent by December. The RBA needs to lift interest rates off their emergency lows to help cool inflation, while simultaneously hoping that wages will rise without causing inflationary problems.

The election victor will need to join the RBA to fight inflation by consolidating the budget faster. Structural budget deficits of $50 billion to $80 billion are forecast over the next few years and gross debt is projected to hit $1.2 trillion.

But neither side is willing to couch spending cuts or tax rises before the election.

Labor says it is spending “only” $7.4 billion more over the next four years to help fund its pledges on childcare, more university and fee-free TAFE places, aged care and a clean energy transition.

Fiscal help needed

That assumes it can raise an extra $9 billion in revenue from cracking down on tax avoidance by local businesses and wealthy people ($3.1 billion) and multinationals ($1.9 billion), ditching consultants and contractors in the public service ($3 billion), increasing foreign investment fees ($445 million) and fines for anticompetitive conduct ($555 million).

Prime Minister Scott Morrison says Labor also ignores $52 billion of “off budget” spending, such as the $20 billion Rewiring the Nation fund to modernise the energy grid and a social and affordable housing fund. He says Labor always spends more and cannot be trusted to manage money.

Treasurer Josh Frydenberg says the Coalition will bank most of a potential $30 billion budget windfall from high commodity prices and low unemployment. But he won’t canvass discretionary spending cuts, beyond a $2.3 billion public service efficiency dividend.

Political plan

Citi economist Josh Williamson says the election spending from both sides is “adding to, or at least not offsetting, the current inflationary pressures”.

“Both political parties have provided various election sweeteners,” he says. “Ultimately, neither has a plan to rein in the current inflationary pressures, and there is little in the way of productivity-enhancing reforms.”

Budget repair and supporting the RBA in its quest to tame inflation will be a task for after the election.

Labor, if elected, will deliver a budget in October to implement its big commitments on $5.1 billion of extra subsidies for childcare and $2.5 billion for aged care, plus investments in skills and climate change.

Chalmers has committed to a Treasury and Finance Department audit of “waste and rorts” – potentially opening the door to a serious “line by line” budget review.

He says Labor will focus on the quality of spending and lifting productivity. It will avoid cuts to two of the fastest-growing expenditure areas – the National Disability Insurance Scheme and aged care.

Beyond the budget, the election winner will also face weak productivity, which has contributed to the decline in real wages.

“We could be doing a lot better with the money we’re raising and spending,” Richardson says. More reform work needs to be done on climate change, federal-state relations, cities, infrastructure, competition and tax, he adds.

“There are medium-term challenges that have not been well addressed during the election.”

The AFR View on Election 2022

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