Inflation, rates and the federal budget expected to hit Aussies hard over next few weeks

Australian households face a critical fortnight with inflation data, the RBA interest rate decision and the federal budget all landing as the US-Iran war ramps up pressures on consumer budgets.

The next two weeks are shaping up to be a make-or-break for Australians who are already struggling with cost-of-living pressures.

According to economists, skyrocketing fuel prices will lift inflation past 5 per cent, forcing the RBA to lift interest rates.

At the same time, Treasurer Jim Chalmers faces mounting pressure to deliver meaningful relief in the federal budget on May 12, while reining in government spending that critics say is fuelling inflation.

With household budgets already stretched to breaking point, the financial squeeze is only tightening.

Cost of living to accelerate

Australia is next week set to get the first clean inflation figures since the start of the US-Iran war that has driven oil prices and is tipped to depress economic activity.

The conflict between the US/Israel and Iran, which started at the end of February, has led to the blockage of the Strait of Hormuz, a critical waterway where one-fifth of the world’s oil once passed daily.

Before the Middle East conflict, oil prices were about $US56 ($A80) a barrel before trading about $US100 ($A143) a barrel.

For every $10 increase in the price of oil, Australians pay an extra 10 cents at the fuel pump.

AMP chief economist Shane Oliver warns that headline inflation could jump by as much as 1.5 per cent when the official data is released on Wednesday.

“We are going to see a spike,” Mr Oliver told NewsWire.

“On our rough estimates fuel prices rose by 30 per cent in the month of March – a bit less for petrol, a lot more for diesel – and that is on its own going to add more than one percentage point to inflation.”

Additional rising costs, including health care, and a flow on from electricity rebates ending would add a further 0.6 per cent to inflation, Mr Oliver predicted.

He expects headline inflation to jump past 5 per cent for the 12 months until March.

He also expects trimmed mean inflation – which strips out seasonality data such as surging fuel prices – to rise slightly over the quarter.

On a quarterly basis – which the RBA prefers – Mr Oliver said the jump in inflation will be smaller compared with the March monthly figure.

In February, Australia’s headline inflation rate rose by 3.7 per cent for the year, while the trimmed mean inflation rate came in at 3.3 per cent.

According to Commonwealth Bank spending data released in mid-April, there was a 2.9 per cent jump in total household consumption, largely due to spikes in oil prices.

The big four banks attribute the bulk of this spending spree to transportation costs, which surged 22.9 per cent in March alone.

Taking out rising fuel costs, spending rose by 1 per cent in March compared with a 0.4 per increase cent in February.

Mr Oliver said inflation will continue to rise but believes there won’t be a repeat of the post-Covid inflation spike, unless the Strait of Hormuz remains closed for an extended period.

Australia's Cash Rate 2022

Cut spending by $100bn, lift the GST and deregulate

Mr Oliver also pointed to the critical role the upcoming federal budget would play in slowing inflation.

Despite households calling for support to help with rising costs, Mr Oliver said the government must resist the temptation to overspend.

National debt is creeping towards $1 trillion, with critics calling on the government to rein in spending in the budget to ease inflationary pressures.

“My wishlist is that any stimulus from the government is limited, well targeted towards businesses and households that need it,” Mr Oliver said.

“It also needs to be temporary and modest because if you pump too much stimulus in you’re just going to make the Reserve Bank’s inflation challenge worse and higher interest rates.”

He said any cost-of-living relief should be modest at about $5bn or 0.2 per cent of gross domestic product.

He also said Australia needed to find $100bn over the next four years in savings to the budget.

Australian government spending is estimated to come in at 26.9 per cent of the country’s GDP.

“Over a four-year period, it would be nearly a 2 per cent GDP reduction, taking government spending back to around its long-term average level,” Mr Oliver said.

“It might sound harsh but the problem is all this government spending has increased the level of aggregate demand in the economy and left little room in home construction, business investment and consumer spending, which has just created an inflation problem that shouldn’t have been there.”

NED-9175-Australia's GDP

He also pointed to the need for real tax reform, including lifting the GST.

“Australia should be refocusing on the balance of the tax system by relying more on the GST and less on income tax,” Mr Oliver said.

“Ideally, you would expand the GST to cover everything and lift the rate from 10 to maybe 15 per cent.”

Mr Oliver conceded this would be politically difficult to pass.

“But you could compensate those who lose out by a rising GST. For example, you could lower the income tax rate or you could lift pension rates,” he said.

Lifting the GST would not only simplify the tax system but also achieve meaningful intergenerational reform, Mr Oliver said.

“You have a whole bunch of people now who are moving into retirement phase who benefited from superannuation and are now self-funded retirees,” he said.

“They won’t be paying much tax because their income going forward would be low, so one way to get money out of them is a consumption tax which can be given back to workers.”

Mr Oliver also said the government needs to wind back some of the red tape on businesses.

“There is too much regulation in Australia which makes it a lot harder for companies to do anything,” he said.

Ahead of the budget announcement on May 12, Treasurer Jim Chalmers spoke of a responsible approach that will focus on resilience and reform.

“There’ll be tax reform, there’ll be a productivity push, and there will be savings,” Mr Chalmers told reporters.

“Cutting compliance costs is a big focus of the government and a big focus of the budget as well.

“It won’t have every single idea that’s been pitched to us over the last 12 months or so, but it will be ambitious in its breadth and in its depth as well.”

As part of these changes, the Labor government has considered ways to increase revenue, including cutting the capital gains discount for property investors and revamping negative gearing.

Currently, homeowners get a 50 per cent discount on capital gains taxes if they hold a property for more than 12 months. Reports suggest Mr Chalmers is in favour of altering this rate over scrapping the discount altogether.

The government has also announced a $15bn cut to the National Disability Insurance Scheme over the next four years.

But it will also have more than $53bn in additional costs over the next decade as part of the National Defence Strategy.

Further rate pain to come

Also weighing on households is the chance of multiple interest rate hikes starting on May 4-5 following the RBA’s next meeting.

The central bank has lifted interest rates twice in February and March by a total of 50 basis points, taking the cash rate to 4.10 per cent.

But money markets widely predict further interest rate pain as the central bank is forced to lift interest rates to stop inflation accelerating.

NED-14886-Australia’s operational oil refineries

EQ Economics founder and managing director Warren Hogan says the conflict in the Middle East is having an impact on the broader Australian economy.

“Core inflation is starting to move; that is the oil price spike is impacting prices more generally and that is not good news because Australia didn’t get inflation under control (last year),” Mr Hogan told Sky News.

Core (also known as underlying) inflation removes volatile components of the consumer price index – typically food and energy – and is the RBA’s preferred measure for where inflation is heading.

Mr Hogan said the RBA simply had to hike more and that puts the nation’s housing market and consumer spending at risk.

“You hope they will learn from their mistakes,” he said.

“There’s no sugar coating it, the strategy failed. It wasn’t a misread of the economy, but it was the strategy of not raising rates as much and thinking that you can get inflation under control failed.

“We will be in a weaker position than other economies because of that strategy. If the economy doesn’t fall into a recession because of this oil price spike and the disruption to supply chain, then we are likely to see quite a bit of inflation come through and the RBA has to lift rates.”

Mr Hogan predicts at least four interest rate hikes in 2026.

Mr Oliver agreed, calling for at least one more interest rate hike in May and possibly a second one in August.

Although he says it will all depend on the federal budget and the conflict in the Middle East.

If the forecast comes true, the cash rate will be back to 4.60 per cent, the highest point since October 2011.

Under a worst-case scenario, Mr Hogan said rates will return to 6 per cent or around levels experienced at the start of the global financial crisis.