$5.4 billion improvement forecast, but interest rate rise still looms
Finance Minister Jim Chalmers will announce a $5.4 billion improvement in the budget by keeping all the extra income provided by the strong job market and improving commodity prices, but this may not be enough to prevent borrowers from being hit by an interest rate increase in the new year.
The mid-year budget update to be published by Chalmers and Finance Minister Katy Gallagher on Wednesday will show the 2025-26 fiscal year deficit will be $36.8 billion. A deficit of $42.2 billion was expected before the May elections.
Despite the improvement, it would still be the ninth largest deficit on record in nominal dollar terms at $36.8 billion.
The projected total deficit over the next four years was revised down from $151.9 billion to $143.5 billion, down $8.4 billion.
The reduction in deficits was driven primarily by strong revenue from the personal income tax, as a better-than-expected labor market combined with ongoing real wage growth. Income taxes are expected to exceed $350 billion for the first time in history.
The budget assumed that iron ore prices would fall from around US$100 ($150) per tonne to US$60 ($90) per tonne by the March quarter of 2026. Instead, iron ore sells for US$106 per tonne. The increase in gold prices, which increased by more than 60 percent this year, also increased revenues.
A better profit is forecast despite an extra $35 billion in spending, including $10 billion in GST to states, $6.3 billion in natural disaster spending and $3 billion in higher age pension payments.
Chalmers will confirm that any extra revenue the government has raised since the budget will be used to improve profitability. It will also reveal that for the first time since the Turnbull government, policy decisions will reduce the deficit over the budget’s forward-looking forecasts.
Before the announcement of budget details, Chalmers said that the country’s financial situation had improved thanks to the measures taken by the government.
“Despite all the pressures we have had to accommodate in the budget, we are achieving a better outcome every year going forward thanks to our efforts,” he said.
“This is the biggest improvement to the budget in a single parliamentary term and is a strong demonstration of Labour’s responsible approach to the country’s finances.”
Smaller deficits will help reduce overall gross government debt.
After Chalmers’ initial budget in 2022-23 was estimated to be more than $1.1 trillion, the 2024-25 fiscal year ended with gross debt of $928.6 billion.
This year the government expected gross debt to reach $1.02 trillion. With just over six months left this financial year, gross debt is now $957.4 billion, suggesting Chalmers could avoid exceeding $1 trillion in 2025-26.
Despite the expected improvement in the budget deficit, there is still a $26.8 billion increase in the deficit recorded in the 2024-25 fiscal year, raising concerns that government spending is increasing the country’s inflation pressure.
The Central Bank kept official interest rates steady at 3.6 percent last week, while financial markets expect a quarter-point increase by August next year.
But on Tuesday economists at both NAB and the Commonwealth Bank said they believed the RBA would cut the cash rate back to 3.85 per cent at its first meeting of 2026, to be held on February 2 and 3.
NAB group chief economist Sally Auld said the economy was already running close to capacity as spending in the private sector started to increase.
“When viewed in the context of a central bank expressing concern about upside risks to inflation and uncertainty about its current policy stance, we think the RBA will need to undertake a modest recalibration of monetary policy in the first half of this year,” he said.
“The half-point tightening will allow the real cash rate to reach a more appropriate level, moving monetary policy to an environment that can better sustain an economy that is growing on trend but not stronger.”
Commonwealth Bank’s head of Australian economics, Belinda Allen, said household spending was rising as inflation pressures eased and economic growth accelerated.
He stated that in past events, an average of nine months passed between the Central Bank’s interest rate reduction and its increase. February’s increase will come six months after the RBA’s last cut in August.
“The risk is that the RBA will not stop with a single rate hike. Our view of a shallow rate-cutting cycle to 2025 and an economy just above the speed limit suggests only fine-tuning is required,” he said.
“We may be wrong. An additional increase may be needed to bring the economy back into balance and bring inflation to the midpoint.”
Cut through the noise of federal politics with news, views and expert analysis. Subscribers can sign up for our weekly Inside Politics newsletter.
Shane Wright- Shane is the senior economic correspondent for The Age and The Sydney Morning Herald.Connect with: excitement or email.
