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• Phase 2 of the strategy, which will address fiscal sustainability. will await further progress on lowering the unemployment rate, presumably comfortably below 5% after previously targeting a level comfortably below 6%. In so doing, both fiscal and monetary policy are working towards a significantly lower unemployment rate than seemed likely prior to the COVID crisis.
• Despite the budget still being in phase 1, the deficit profile will be upgraded significantly due to the much better than expected recovery. NAB expects the 2021-22 budget will forecast a deficit in the order of $70-80bn (down from last October’s expectation of $112.0bn and December’s MYEFO estimate of $108.5bn). The market is expecting a deficit of $80bn. A more significant deficit improvement will be seen in the 2020-21 figure with consensus at $152bn against $197.7bn in MYEFO.
• The Government’s economic forecasts contained in the budget should closely match the RBA’s SoMP forecasts released on Friday, which forecast an unemployment rate of around 4.5% at the end of 2022. This is very similar to NAB’s forecasts. The latest JobSeeker numbers also highlight the risk the unemployment rate falls more quickly than the RBA’s updated forecasts with 105k people coming off JobSeeker in April. A similar fall in unemployment could drop the unemployment rate below 5.0%
• The faster than expected recovery and the flow on improvement in the budget deficit are putting pressure on the RBA’s unconventional policy settings. NAB expects the 3-year yield target to not be rolled to the November 2024 bond, given the substantial progress already made on reducing unemployment. In a similar vein, the much lower budget deficit is expected to see the RBA announce a reduced QE program in July for after the end of QE II program in September. To continue to purchase AGS at the current rate of $80bn every six months (and $20bn in semis) would mean the RBA would likely purchase all of the Government’s debt to be issued in 2021-22, which would likely have a significant impact on bond market functioning. Despite these expected changes to unconventional monetary policy settings, the RBA’s main policy tool, the cash rate, could remain at 0.1% beyond April 2024 if sufficient progress were not made on the wages and inflation front.

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