Deficit makes rate cuts less likely: economists

Swan quotes.
Swan quotes.

The Reserve Bank will be under less pressure to make further cuts in interest rates as a result of Wayne Swan's move to ditch plans for a rapid return to budget surplus, economists say.

The Treasurer conceded on Thursday that he would allow the budget to remain in the red this financial year because delivering a surplus would have required savage cuts to spending.

The chief economist at NAB Capital, Rob Henderson, said that if Labor had instead embarked on the deep cuts needed for a surplus, it would have squeezed the economy and increased the case for cutting the cash rate below its all-time low of 3 per cent.

''It means that extra pressure won't be applied on the RBA to reduce rates further,'' Mr Henderson said.

''If they needed to tighten fiscal policy materially in order to maintain a surplus promise, which was another option, that would have weakened the economy even further and therefore the risk was that the RBA would have needed to cut rates even more.''

Financial markets are betting the Reserve will lower the cash rate to 2.5 per cent over the next year, but these odds were virtually unchanged after Mr Swan's concession Thursday.

Most economists said abandoning the surplus commitment was a realistic move that would have little impact on how the economy was perceived by foreign investors.

However, Mr Henderson added that it could have the perverse effect of keeping the Australian dollar higher – a key reason for the economy's weakness. This is because staying in deficit would require the government to issue more bonds on global markets, which could attract further interest from overseas sovereign funds in the Aussie dollar.

The comments came as the political stoush over the surplus gathered momentum, with the Coalition continuing its attack on Mr Swan's promise.

The shadow Treasurer, Joe Hockey, argued the government was to blame for the deficit because it had locked in spending that was funded by the mining tax, which has been hit by a slump in global commodity prices.

He would not guarantee whether a coalition government could deliver a surplus for every year that it was in office because it had not seen all of the information on the state of the budget.

''I don't know what the books look like. I mean I'm as confused about the state of the nation's finance as you and everyone else and even Wayne Swan,'' Mr Hockey said on ABC Radio.

Mr Swan argued the revenue outlook facing the government had deteriorated dramatically, and this warranted the change in tack.

This story Deficit makes rate cuts less likely: economists first appeared on The Sydney Morning Herald.