Cliff Notes: Shifting Fiscal Priorities and Monetary Expectations

Key insights from the week that was.

The key release for Australia this week was not a data point but a preview, with Westpac Economics outlining our expectations for Budget 2022, brought forward to March this year given the timing of the next Federal election. Chief Economist Bill Evans outlined the key themes and forecasts we expect in his video update; our written preview provides full detail.

Most notable is that, with the economy having recovered from the pandemic and inflation pressures prevailing, we expect the Government’s priorities to shift from supporting demand to supply, albeit while also seeking to help households with cost of living pressures. A focus on budget repair is also anticipated. Of the $78bn improvement in the budget bottom line we expect to be announced over the forward estimates, $58bn will be directed to lowering the deficit and reducing debt.

Ahead of the Budget, our latest edition of Coast-to-Coast provides a full view of conditions and growth opportunities across Australia’s states.

Over in New Zealand, concerns over the cost of living are clearly front of mind for consumers, sentiment falling to its lowest level since the GFC. In addition to elevated inflation, rising interest rates are also pressing discretionary incomes. Amplifying the effect of these cost of living pressures on confidence, while the NZ labor market is unquestionably strong and consumers are positive on job opportunities, current and expected earnings growth remains below pre-pandemic levels.

Then to the US. Data might have been sparse this week, but FOMC speakers were certainly not. Underlying all of the Committee members commenting this week was one critical concern: the outlook for inflation. This was most apparent in Chair Powell’s speech which, with respect to policy, had a near singular focus on inflation. Making this possible is the FOMC’s very strong confidence in the economy and its resilience. Also, Committee members look to be holding a view that the longer inflation is materially away from target, the greater the likelihood of inflation expectations becoming unanchored.

To us, Chair Powell and the Committee are making it clear they intend to tighten policy aggressively in coming months, with the consequences to be assessed later. As such, we now look for back-to-back 50bp rate hikes in May and June and a 25bp rate hike at each of the remaining meetings in 2022. That would leave the fed funds rate at 2.375% by December 2022, six months earlier and 50bps higher than our prior peak. Note however, this is not to say we have become more optimistic on the outlook for real income growth or financial conditions and consequently the US’ growth prospects.

Instead, we expect this fight against inflation to come at a cost in 2023, with US’ growth to end that year below trend and the unemployment rate higher at around 4.5%. Also, it is entirely possible that real wages won’t fully recover by end-2023, having declined through 2021 and the first half of 2022. As soon as inflation is brought back to near target, likely late-2023, we anticipate the FOMC will need to reverse course, taking on an easing bias and then cutting twice in 2024 to a fed funds rate of 1.875%. This shift in the policy stance will become apparent in term interest rates through 2023 then stabilize in 2024 as the cuts are delivered.

Returning to Australia, note that global developments and the hawkish response of the FOMC provide scope for the RBA to move more quickly, once the hiking cycle has been justified by domestic developments. As outlined by Chief Economist Bill Evans, we still expect the RBA’s hiking cycle to begin in August, but that first move is now expected to be followed by hikes in October and December, then once per quarter through 2023. This means the 1.75% peak cash rate for this cycle is now seen three months earlier in December 2023.

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