Australia’s federal budget – specifically, federal budget deficit – was a key talking point into the end of last year, after the Morrison government deployed record amounts of stimulus to shield the economy from the pandemic.

From a forecast surplus of ~$5bn, the government announced a project deficit of $213.7bn for the 2021 financial year.

But with a V-shaped economic recovery and booming commodity prices, UBS reckons that from a projected deficit of $213.7bn for FY21, the government may now be able to get back into surplus as soon as 2024/25.
 

Bouncing back

The UBS team, led by economist George Tharenou, attributed the “main driver” of budget repair to the strength of Australia’s economic rebound and a healthy jobs market.

Earlier this month, CBA economist Gareth Aird said the consistency of monthly beats in domestic employment numbers had “surprised the entire forecasting fraternity”.

In addition, Australia’s employment-to-population ratio has now rebounded to “near a record high”, UBS said.

More people in work means more people contributing tax revenues (income), and less people in need of JobKeeper support (expenses).

“However, a stronger-than-expected global economy contributed to much higher-than-expected commodity prices, especially iron ore,” UBS added.

Importantly, the current price point above $US180/t is around triple the government’s conservative forecast of a fall back to $US60/t, which factors into its federal budget assumptions.

As a result, “we think higher prices should add at least $20bn to the budget position (and more if sustained ahead)”, Tharenou said.
 

Budget deficit crystal ball

Along with strong employment data and the ongoing outperformance of iron ore, UBS noted that business profits have rebounded while asset prices (such as property) are “booming”.

So instead of the $213.7bn deficit forecast that the government handed down last October, the analysts reckon the actual FY21 deficit will be more like $163bn.

That kind of improvement indicates the government has escaped with “limited structural scarring” on the budget from the pandemic.

“Hence, it’s plausible the budget will project a return to balance in 24/25, with a cumulative improvement of ~$200bn across the profile,” UBS said.
 

Interest rates

With the government on a march back to surplus by 2024/25, UBS said the current trend will result in a “material reduction” to its borrowing commitments in the bond market.

Right now, the RBA is buying around $5bn of bonds per week as part of its quantitative easing program, which it has committed to through to August.

Unless it tapers, the central bank will end up owning half of all Australian government bonds by the end of this year, UBS said.

But Tharenou doesn’t expect the RBA to pause QE entirely. Rather, a taper is on the cards which could see weekly bond purchases halve in August before stopping by the end of the year, he said.

He added that the argument to extend the RBA’s yield curve control program on three-year government bonds has “materially weakened”.

“Nonetheless, the RBA is still likely to hold the cash rate over our forecast profile, to at least the end of 2022,” Tharenou said.