RBA to cut rates to ensure economic growth as government commits to budget surplus: AFR’s Alan Mitchell

The Reserve Bank will cut interest rates to spur on economic growth as the federal government remains committed to achieving a budget surplus in 2012-13, according to Alan Mitchell, economics editor at the Australian Financial Review.

Yesterday Federal Treasurer Swan released the budget outcome for the 2011-12 financial year showing a slightly better deficit outcome of $43.7 billion and restated the government's commitment to return the budget to surplus in 2012-13

Swan also acknowledged that the decline in commodity prices would inevitably make the task more difficult as it targets a very small underlying cash surplus of $1.5 billion for 2012-13.

Mitchell says the RBA’s concern will be the “impact of fiscal policy on economic output and inflation over the next two years”.

“The savings needed to balance the budget in the next two financial years are now more manageable, but they will be in addition to all the other sand that is being thrown into the economy’s wheels from the truncation of the mining investment boom, the global economic uncertainty and the strong dollar,” he says.

“With inflation already low, the RBA will cut rates to support economic growth. That will help exchange rate- and interest rate-sensitive activities including housing, manufacturing and tourism.”

A similar sentiment is echoed by HSBC Australia chief economist Paul Bloxham in a commentary piece examining how the current mining boom differs from past mining boom.

Bloxham says the financial system is “not overly leveraged into the mining story, as it has been on some occasions in the past".

“Having escaped the global financial crisis reasonably unscathed, Australia's banking system is also in pretty good shape such that conventional monetary policy still works.

“When the mining story fades, which is not yet, there will be room for other sectors to pick up and growth to rebalance. Rebalancing will be assisted by the steady Australian dollar and below-average RBA rates, though some further adjustment to RBA rates will probably be necessary.

"We continue to expect another RBA cut before year-end.”

Bloxham also warns that achieving the “political imperative” of achieving a surplus will be even harder given the recent falls in commodity prices.

“Discretionary fiscal tightening in the face of weakening conditions, if it occurs, does not seem like the right move, in our view, but it is a risk. 

The chief risk he says is China.

“Our central case holds that China's growth cycle is currently bottoming out, with growth forecast to pick up to 8.4% next year. This is expected to support demand for commodities and prevent prices from falling too much further.”