A Tough Budget with Tax Confusion as the Economy Slows

The Federal Budget delivered a modest tightening in fiscal policy. There were some cuts in spending (the NDIS in particular) plus a range of tax changes which add to government revenue, particularly over the medium term. The budget is forecast to remain in deficit in each of the next four years, but only to the tune of 1 per cent of GDP. Net government debt is forecast to edge up to 22 per cent of GDP in 2029-30 from 20 per cent at present.

The proposed tax changes, particularly as they relate to capital gains, have generated considerable backlash from parts of the business sector. There has also been some confusion on the specifics of the tax changes which may see them amended before they pass the parliament.

The recent data flow in Australia has been mixed.

GDP rose 0.3 per cent in the March quarter for an annual increase of 2.5 per cent. Private sector demand accounted for all of the growth with business investment (notably data centres) registering particularly strong growth. Household spending grew moderately, while public demand weakened and net exports subtracted from bottom line GDP growth due in part to a surge in import volumes (see data centres again).

A range of partial economic indicators for the June quarter are pointing to a further slowing in conditions.

Employment fell 19,000 in April with the unemployment rate jumping to 4.5 per cent, the highest rate in over four years. With job vacancies still weak, the unemployment rate is expected to increase further.

Annual inflation eased from 4.6 per cent to 4.2 per cent in April but remains above the RBA target. It is noteworthy that around one third of the increase in inflation is directly linked to three items – petrol, the ending of electricity subsidies and tobacco excise increases. With these temporary factors excluded, trimmed mean inflation is broadly steady at 3.4 per cent.

Growth in household spending is trending lower as consumers react to the three interest rate hikes since February 2026, higher oil prices and rising unemployment. The number of building approvals are solid, pointing to a strong upturn in the construction sector in the year ahead. There was also good news with a 6.5 per cent jump in business investment in the March quarter with annual growth lifting to a 14 year high. The surge in Capex is an important leading indicator for future productivity gains.

Nation-wide house prices recorded no change in May with falls in Sydney, Canberra and Melbourne. The rate of price increases in the other cities is slowing. While the RBA does not target house prices, it is a strong proponent of the wealth effect from house price changes on household consumption. If, as appears close to certain, house prices fall over the next 12 to 18 months, a negative wealth effects will compound any weakness in household spending and add to the disinflationary pulse that is likely to begin in earnest over the latter part of 2026.         

Financial markets have scaled back expectations for further RBA interest rate hikes. No change in rates is expected at the 16 June RBA meeting and there is just one more 25 basis point hike priced in by year end. The market is starting to price in interest rate cuts in 2027.

New Zealand

While the RBNZ left interest rates steady at the cyclical low of 2.25 per cent at its May meeting, it signalled a strong bias to start an interest rate hike interest rates in the near term as inflation pressures and a modest economic recovery gain momentum.

The recent economic news in New Zealand has been mixed. After sharp falls in the wake of oil shock, business and consumer sentiment have ticked higher in the latest surveys. Inflation remains above target level at 3.1 per cent in the March quarter despite considerable slack in the labour market. The unemployment rate is above 5 per cent and is expected to remain above that level through to 2027.

Like in Australia, wages growth is low and expected to ease though 2026, which should help to contain inflation pressures.

Based on the above, markets are pricing in around 100 basis points of interest rate hikes from the RBNZ over the next 12 to 18 months.

Currencies

The AUD remains strong holding near 0.72 US cents for the bulk of the last month. The budget had no material effect on the AUD. The NZD has edged higher to be above 59 US cents, but this is still below the recent peak of 60.75 US cents in February. The AUD/NZD cross has stabilised around 1.20 to 1.22.