• Almost each day there is a new piece of speculation about likely measures to be contained in the Federal Budget to be handed down in a fortnight’s time. But one aspect of the budget that is known with some degree of certainty is the economic setting. The table below shows the economic state of play, comparing current variables such as economic growth and inflation to those that existed a year ago ahead of the 2013/14 Budget.
• Arguably the economy is in better shape than a year ago and the outlook is more positive with home building taking over from mining as a key driver of growth. In addition the latest numbers indicate that the Budget bottom line is in better shape than a year ago. The deficit for the year to February 2014 is 1.6 per cent of GDP, down from 2.5 per cent of GDP a year ago.
• But the Government is highlighting the medium-term challenges, not the modest short-term improvement in our fiscal circumstances. Spending commitments for Education, the National Disability Scheme and Defence must be met from revenues that are slowing with the ageing population.

What do the figures show?

Overall, variables such as economic growth, inflation and unemployment aren’t greatly different now compared with a year ago. But a year ago the economy was slowing as consumers and businesses elected to wind back spending ahead of a September election. As a result the Reserve Bank decided to cut interest rates in both May and August to support the economy, driving the cash rate to the lowest level in 53 years. Today the economy appears to be gathering momentum, not slowing down, causing economists to speculate about rate hikes, not rate cuts.

• The big changes over the past year have been the easing of the Australian dollar and lift in demand for homes and thus higher home prices. The Aussie dollar is around US10 cents lower than a year ago, providing support for the export sector. And nationally, home prices are currently more than 10 per cent higher than a year ago, compared with annual growth of 2.4 per cent a year ago.
• The unemployment rate is at present only modestly higher than a year ago. But in 2013 the economy slowed, leading to a weaker job market and culminating in the jobless rate peaking at 6.1 per cent in February 2014. A further by-product of the weaker job market was a slowdown in wages with annual growth falling to a record low of 2.6 per cent. While unemployment fell in March from 6.1 per cent to 5.8 per cent, it is by no means certain that unemployment has definitively peaked. But certainly there is a raft of indicators that are suggestive of a stronger job market ahead.
• While inflation is higher than a year ago, the underlying rate remains locked in the Reserve Bank’s 2-3 per cent target band. A weaker Aussie dollar has pushed up prices of imported goods and pushed up the headline inflation rate, but lower labour costs are serving to keep price pressures in check.
• The sharemarket recently hit the highest levels in six years and is up around 7 per cent over the past year. The combination of higher home prices and higher share prices has lifted household wealth to record highs. Record wealth, lower interest rates and the removal of election uncertainty have underpinned a solid recovery in consumer spending.

What are the implications?

• The Government is laying the groundwork for a tough Budget on May 13, similar to the strategy adopted by the Howard/Costello Government in its first Budget in 1996. The 2014 Budget is being framed in a generally favourable economic environment with most analysts expecting firm domestic growth and a more benign global environment.
• The Government will seek to highlight the medium-term challenges ahead; arguing now is not the time for complacency, but the time to shore up the defences to meet the future challenges. Australia’s current budget deficit of 1.6 per cent of GDP does compare favourably with deficits of 4.1 per cent in the US, 6.7 per cent in the UK, 2.9 per cent in the Euro area and 1.8 per cent in China. Australia has the 17^th lowest budget deficit to GDP ratio of 57 countries covered by The Economist magazine.
• The risk for the Government is that the rhetoric of austerity could prove too negative, causing consumers to again trim spending and cause businesses to delay investment plans. The forthcoming budget will need to strike a balance: support the current economic recovery and thus employment and tax collections, while at the same time putting measures in place to deal with medium-term fiscal challenges. The Government will need to be convincing in selling the need for fundamental change if it is to secure both community and Senate support.