Federal budget spending pushed interest rate move by RBA: Economists

Cost of living spending in the federal budget “100 per cent” helped pull forward the Reserve Bank’s decision to increase official interest rates, economists believe, and they warn most Australians will suffer real falls in wages over the next 18 months.

As Prime Minister Scott Morrison and Treasurer Josh Frydenberg defended their handling of the budget, senior economists said the extra spending promised by both sides of politics in the election campaign was adding to inflationary pressures.

Scott Morrison, on the campaign trail on Wednesday, said the government was dealing with major international inflationary pressures.Credit:James Brickwood

The RBA on Tuesday lifted the official cash rate by 0.25 percentage points to 0.35 per cent, the first increase since 2010 and the first during an election campaign since 2007.

The bank said it would be the first of a string of rate rises to deal with inflation that the RBA is forecasting will reach 6 per cent with underlying inflation on track to hit 4.75 per cent. Inflation is not expected to be back within the RBA’s 2-3 per cent target band until mid-2024.

The March 29 budget contained $25 billion in extra spending initiatives over the next four years, including $5 billion for the $250 cost-of-living bonus and the 22.1 cents a litre reduction in fuel excise.

The super-sized low and middle-income tax offset, which will start flowing into bank accounts from early July, will pump at least $12 billion into the economy.

Economist Steven Hamilton, a visiting fellow at the Tax and Transfer Policy Institute at the Australian National University, said there was no doubt the extra spending in the budget – on top of what was being promised by both major parties during the campaign – had been a factor in the Reserve Bank’s move.

“Interest rates are higher than they would otherwise be because of the budget, 100 per cent,” he said.

“The RBA is targeting where inflation will be in about 12 months’ time. You can’t inject about 1 per cent of GDP into the economy and not have an impact,” he said.

Grattan Institute economics policy director Brendan Coates said it was clear the budget’s extra spending was adding to the nation’s inflation pressures, forcing the RBA to act.

“The RBA is looking at inflation over the next 12 months and where it’s going to be. The budget has at least 1 per cent of GDP in discretionary spending so interest rates obviously have to be calibrated to take that into account,” he said.

RBA governor Philip Lowe on Tuesday said there was a “lot of positive momentum” in the economy at present with the bank forecasting the economy to expand by more than 4 per cent this year.

He said fiscal policy was playing “some role” in that expansion but said other factors, such as pent-up demand from the pandemic recession, were the main factors at present.

Morrison, campaigning in South Australia, said the Reserve Bank had made clear there were “many pressures” on inflation and interest rates, with the government using its cost of living measures to help taxpayers deal with those pressures.

Frydenberg, in a debate with shadow treasurer Jim Chalmers, said Treasury had made clear when putting together the budget that the cost of living measures would not have a material impact on inflation.

Josh Frydenberg and Jim Chalmers during their treasury debate at the National Press Club.Credit:Liv Cameron

“If you look at the statement from the Reserve Bank [on Tuesday], they were very clear – in their words, these are not mine, the main driver of inflation has been international factors,” he said.

Treasury did forecast inflation to reach 4.25 per cent this financial year and then edge down to 3 per cent, well short of what the Reserve Bank now expects.

Frydenberg said for someone on full-time average earnings, inflation would out-pace wages growth by $900 this year but the government was delivering $1500 in tax relief from July 1.

Beyond that, wages growth is still expected to be short of inflation, leaving people going backwards until the second half of next year.

Chalmers said the government’s own forecasts on wage growth meant many people were facing a $1355 cut in real wages.

He said with inflation forecast to reach 6 per cent, the biggest risk at the election was that nothing changed.

“It takes an especially out-of-touch Liberal treasurer in the context of skyrocketing inflation out of control and falling real wages and rising interest rates and consumer confidence plummeting, his key argument at this election is he wants to stay the course,” he said.

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