Market reaction to Australia’s new Labor government will be ‘muted’, economists say

The incoming Labor government faces a number of economic challenges, from soaring inflation to slowing economic growth, but economists and rating agencies say those potential storms can be weathered and the markets will follow suit.

With investors pricing in a change of government in Saturday’s federal election, the reaction in stocks and other markets will be “muffled,” predicted Gareth Aird, the chief economist at the Commonwealth bank.

In early trading, the benchmark ASX200 stock index was up about a third of 1% before wiping out gains. The Australian dollar was also slightly stronger against the US dollar.

“Who Won the Government” [on Saturday] night would inherit an economy with high inflation and a very tight labor market, and therefore … a central bank that had to respond,” he said.

“I don’t think there’s anything in what we’ve heard in the election campaign that the dial in your economic forecast would shift in a material sense for the next 12 to 18 months.”

The Treasury Secretary, Steven Kennedy, met the new treasurer, Jim Chalmers, at his home in the Brisbane suburbs on Sunday afternoon to hand over the government briefing known as the “red book,” the Australian Financial Review reported.

Aird predicts that the Reserve Bank will raise the spot rate of 0.35% at each of its next three board meetings, with the first on June 7. Investors are betting on a rapid rise in interest rates as the bank tries to wipe out inflation expectations after consumer prices rose 5.1% in the March quarter, with underlying inflation at its highest level in 13 years.

Alan Oster, chief economist of the NAB group, expects the RBA’s cash interest rate to be around 1.5% by the end of the year. (A 1 percentage point rise in interest rates increases repayments on an average Sydney home loan by nearly $500 a month and $350 in Melbourne.)

The RBA is independent from the government, as is the Fair Work Commission, which will make its annual statement on raising the minimum wage at the end of June – another economic signal beyond the government’s control.

Despite Labor’s charges released Thursday (which revealed a net $7.4 billion in additional spending over four years) sparking some media coverage of economic management, Oster said he “didn’t really see much of a difference.” between both sets of policies”.

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“The Australian economy is over $1 trillion a year, so an extra $10 billion is really nothing,” he said. “I don’t think it’s a bad set of books [for Chalmers to inherit]† There are a lot of uncertainties globally, but locally – provided the Reserve Bank doesn’t get stupid, and I don’t think they will – then we’ll be fine.”

Oster’s top three concerns are slowing growth in China as that country battles to contain Covid outbreaks; Europe’s year-end target to get rid of Russian oil and gas; and an overly rapid rise in interest rates by the US Federal Reserve that is stifling US growth.

“The kind of concerns that scare us into the US, don’t scare us out of Australia,” he said.

Both Oster and Aird expect the Australian dollar to strengthen against the US dollar over time. On Sunday, the local currency traded above 70 cents.

The Australian dollar is hovering around $70.5 after the weekend elections resulted in a Labor government. Economists predict the currency will strengthen against the greenback, although China’s Covid restrictions are among the headwinds.

— Peter Hannam (@p_hannam) May 22, 2022

Based on skyrocketing commodity prices, the Australian dollar should trade at about 78 cents and approach that level next year, Oster said.

David Plank, ANZ’s head of Australian economics, said it only took one shock to “blow you completely off the expected path – and both ways, as not all shocks are negative”.

In the next fiscal year, risks in the deficit projection are currently on the downside, in part due to high iron ore and other commodity prices, pushing up both royalties and corporate profits.

†[The] The nominal economy looks much stronger than the Treasury had anticipated at the time of the budget,” Plank said, using a lower-than-projected unemployment rate to cut spending, while inflation will boost tax revenues as the nominal economy grows.

On the other hand, there will be “a lot of spending pressures built into current policy settings,” ANZ said ahead of the election.

“The rapid growth in expenditure on the NDIS is an example of this, elderly care is another example. This pressure will have to be managed regardless of who wins the election, especially given that significant tax reform appears to be off the table.

Economic data releases were prominent during the election campaign, with rising consumer prices and weak wage data tarnishing the reputation of the Morrison government’s economic management and the unemployment rate of 3.9% for April polishing them.

Ahead of the RBA meeting, the Australian Bureau of Statistics will release GDP data for the March quarter on June 1. The Omicron disruptions will mean the quarter-over-quarter figure could reach 0.2%, but the 2022 average will be 4% before slowing to about half next year, Oster said.

Rating agencies are also allowed to vote on Australia’s economic governance, and for now all the big three – Fitch, Moody’s and S&P – show no signs of a rushed overhaul of the country’s much-vaunted triple-A debt rating, even as gross federal The Treasury estimates that debt will reach $1 trillion in 2023-24.

A write-down would increase the cost of borrowing, with investors demanding a higher yield to buy the debt.

Anthony Walker, Analyst at S&P Global Ratings, said that despite rising interest costs, “Australia’s ability to service its debt is very high,” reflected in its “AAA” rating.

“We expect interest expense to rise to about 4.2% of revenues in the coming years, from 3.8%, as a result of higher yields and rising debt,” he said.

“However, higher borrowing costs won’t take a big chunk out of the budget in the short term because some refinances are actually at lower interest rates than in the past.”

Jeremy Zook, the director of Fitch’s rating for Asian-Pacific government bonds, agreed that higher government borrowing costs will add only “modest” fiscal pressures in the coming years.

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