Australian Budget 2025-26 preview

OK, so perhaps it wasn’t the most dramatic thing to happen since the last weekly note. Germany’s vote to reform its ‘debt brake’ is probably a stronger contender. But Newcastle United’s historic victory in the Carabao Cup is up there. (Apologies to readers for this brief diversion from regular content, but please indulge me: It’s been a long wait.)

Moving swiftly on. Next week, the Treasurer will deliver the Budget that nobody expected until ex-Tropical Cyclone Alfred cruelled the government’s plans for a widely anticipated 12 April election. We preview Budget 2025-26 below, suggesting six things to watch. We also offer some international perspective around Australia’s fiscal numbers to give context to debates around debt burdens and the size of government. I will attend the Budget lockup as usual next week and the AICD will send out its regular Budget night report.

On the domestic data front, this week brought the February 2025 Labour Force release. The ABS reported a surprising and sizeable drop in employment, contradicting market economists’ forecasts for another monthly increase in job numbers. While a concurrent fall in the participation rate meant the unemployment rate nevertheless remained unchanged at 4.1 per cent, this was another piece of data that should offer the RBA reassurance regarding the appropriateness of its February 2025 rate cut.

This week also brought the release of the OECD’s latest forecasts for the world economy. The new numbers included downgrades to the growth outlook and upgrades to inflation prospects. Until now, we have been describing Trump 2.0 as a great big uncertainty shock. That is probably still the best way to characterise recent developments. But the OECD report suggests an alternative description. Perhaps we should also start thinking of Trump 2.0 as a stagflationary shock. That is, as significantly bad news for both economic growth and inflation. Granted, we shouldn’t take this too far yet. After all, the OECD is still predicting continued global disinflation, even if it now thinks the process will be slower than before, thanks to all those tariff increases.

Mind you, it’s not just the OECD. At its meeting this week (at which it left the target range for the federal funds rate unchanged at 4.25-4.5 per cent) the US Federal Open Market Committee (FOMC) released its own updated forecasts for the US economy. Fed officials have trimmed their median forecast for GDP growth this year from the 2.1 per cent they were anticipating back in December 2024 to 1.7 per cent now; they judge that headline PCE inflation in 2025 will run at 2.7 per cent instead of 2.5 per cent and that core PCE inflation will be 2.8 per cent instead of 2.5 per cent; and they reckon that the unemployment rate will rise to 4.4 per cent instead of 4.3 per cent. In short, Fed officials also think growth will be slower and inflation will be higher than they had anticipated late last year. Yes, financial markets took a degree of comfort in the fact that there was no change to the FOMC’s median projection for the mid-point of the target for the fed funds rate at end-year. That remained at 3.9 per cent. But simultaneous upgrades to inflation projections and downgrades to growth expectations have at least a whiff of stagflation about them.

Please also join us this week for the latest episode of the Dismal Science Podcast.

Now, onto all the detail.

Is the Trump 2.0 uncertainty shock turning stagflationary?

The March 2025 OECD Interim Economic Outlook arrived this week. This is the first of the big international organisation reports on the global economy to reflect the impact of the initial weeks of the new administration in the United States and what we’ve been describing as the Trump 2.0 Uncertainty Shock. Next month will bring the IMF’s analysis on developments in the form of a new World Economic Outlook.

Meanwhile, the OECD’s take is that recent economic indicators point to a softening in global growth prospects across the first quarter of this year, including in the United States, Mexico, and Canada. A dramatic rise in policy uncertainty has been accompanied by softer business and consumer sentiment. At the same time, inflationary pressures linger in many economies, reflecting stubborn services inflation, tight labour markets and a pickup in goods inflation, albeit from very low levels. And global financial conditions have tightened, while market volatility has increased.

Put all this together and the OECD’s baseline forecast now assumes that global growth will slow from 3.2 per cent in 2024 to 3.1 per cent this year and then soften again to three per cent in 2026. Compared to the OECD’s December 2024 Economic Outlook projections, world GDP growth is now expected to be 0.2 percentage points lower this year and 0.3 percentage points lower next year.

Note that in this baseline forecast, the OECD assumes that the Trump administration maintains its 20-percentage point increase in US tariffs on China and the 25-percentage point increase in steel and aluminium tariffs. It also assumes that the 25 per cent tariffs on Mexico and Canada (with lower 10 per cent rates for Canadian and Mexican Potash exports and for Canadian energy exports) go ahead in full once the temporary exemption for USMCA-compliant trade expires. And it likewise assumes that existing Chinese retaliatory measures remain in place and that Canada and Mexico pursue equivalent retaliatory tariffs. But the baseline projections do not assume any further tariff increases, even though the Trump administration has promised another round of trade policy measures with effect from 2 April.

The OECD also forecasts that headline inflation across the G20 will slow from 5.3 per cent in 2024 to 3.8 per cent this year and to 3.2 per cent in 2026. Although it still expects disinflation, it now thinks the process will be slower, despite having trimmed its growth forecasts. The OECD reckons G20 inflation this year and next will be 0.3 percentage points higher than was the case back in December, due to both the incorporation of more recent data and the gradual inflationary impact of tariff increases.

So, the OECD has downgraded overall growth forecasts, even though it has increased inflation forecasts. While the magnitudes involved are limited and the OECD thinks disinflation will continue, that combination nevertheless represents a modest stagflationary shock to the world economy.

Furthermore, the Interim Outlook warns that current elevated levels of geopolitical and policy uncertainty represent significant risks to these baseline projections. If bilateral tariffs increase on all non-commodity imports into the United States and there is a response by trading partners, the OECD estimates that a 10-percentage point rise in protection rates will translate into a 0.3 per cent fall in global growth and a 0.4-percentage point increase in global inflation over the first three years. Should policy uncertainty increase further under such circumstances – which seems likely – then the hit to confidence and growth will be larger still.

Other downside risks include the chance that inflation proves to be stickier than market expectations assume, which could be the case if higher tariff rates push up not just goods prices but also inflation expectations and that adverse developments in growth and inflation could trigger rapid financial market re-pricing.

Upside risks, on the other hand, include the possibility of a swift reversal in the current trajectory for trade policy which would then push growth up and inflation down, relative to the baseline forecast. Other upside risks include the possibility of a positive geopolitical surprise in the event of successful peace agreements in Europe and the Middle East and the likelihood of a further decline in global energy prices (since markets expect excess global oil supply this year).

Finally, note that the OECD’s new projections do not include the possibility of an increase in debt-financed defence spending along the lines of plans emerging in Germany and perhaps elsewhere.

Before moving on, it is worth noting the OECD’s views on Australia’s economic prospects. In the case of activity, the baseline forecast says growth here will pick up from 1.1 per cent last year to 1.9 per cent this year, before easing slightly to 1.8 per cent in 2026. The projection for 2025 is unchanged from December, but the OECD has trimmed next year’s growth forecast by 0.7 percentage points. At the same time, it now expects headline inflation to moderate from 3.2 per cent to 2.4 per cent and then to 2.2 per cent over the same period, while core inflation is forecast to follow a similar trajectory. In both cases, those new inflation forecasts represent a modest upgrade of 0.1 percentage points this year and a downgrade of 0.4 percentage points next year.

Previewing next week’s budget – Six things to watch

Next Tuesday, Treasurer Jim Chalmers will present the 2025-26 Budget. The baseline for the upcoming budget is given by last December’s Mid-Year Economic and Fiscal Outlook (MYEFO) which projected that the underlying cash balance in 2024-25 would be a deficit of $26.9 billion or one per cent of GDP. That shortfall was expected to increase to $46.9 billion or 1.6 per cent of GDP in 2025-26, with the cash balance then remaining in the red through the remainder of the forward estimates (to 2027-28) and only returning to a marginal surplus by 2034-35.

That profile implied a ratio of net debt to GDP increasing from a projected 19.6 per cent in 2024-25 to 22.4 per cent by 2027-28, before easing back to 19.2 per cent by 2034-35. By the end of the forward estimates, the MYEFO forecast net interest payments to have climbed to 0.9 per cent of GDP.

So, what should readers watch out for next week? Here are six things to keep an eye on:

1. While the December MYEFO reminded us that the two years of budget surpluses recorded in 2022-23 and 2023-24 were set to be succeeded by a sustained shift into the red, a question remains over how big the swing into deficit will be, particularly in 2025-26 given the inevitable temptation to splash the cash in the context of a looming federal election. We have already seen new spending commitments announced around Medicare funding, student debt relief, infrastructure investment and disaster relief for ex-Tropical Cyclone Alfred, for example. In a speech this week, the Treasurer gave his own Budget preview which implied there may not be many more big announcements to come on Budget night, noting that ‘Treasury doesn’t expect the bottom line this year or over the forward estimates to change very substantially from MYEFO.’ So, just how much cost-of-living relief and other pre-election sweeteners will Budget 2025-26 deliver beyond those already promised, and what will this do to the bottom line?
2. Budget 2025-26 will see the release of new economic forecasts from Treasury. The global economic outlook has changed significantly since the MYEFO. The domestic inflation-interest rate story has also shifted, if more modestly. And the economy has just taken a hit from Cyclone Alfred. Despite all this, the Budget forecasts are likely to continue to forecast a soft landing and a recovery in economic growth through this year, but it will be interesting to see to what extent Treasury has tweaked the outlook.
3. A big story in recent budgets has involved large upside ‘surprises’ in the form of revenue upgrades. These have partly been the product of Treasury adopting conservative forecasts for commodity prices (which later produce better than projected company tax revenue results) as well as of stronger-than-forecast employment outcomes (which boost income tax receipts and reduce government payments). The government has chosen to bank most of these revenue gains and that combination of revenue upside plus relative prudence has been the key driver of those two back-to-back budget surpluses. This time, the scope for a similar kind of revenue surprise looks much reduced. According to the Treasurer, ‘Treasury expects any upgrade next week to be about a sixth of the average of our budget updates. The smallest revenue upgrade of the four Budgets, by far.’ He explained that this was due to softer commodity prices and volumes as well as labour market normalisation.
4. Another recurring theme in recent budgets has been spending pressures associated with six key areas, including five big programs plus a growing interest service burden (the latter pushed up in part by a larger debt stock but also by higher interest rates). Watching how growth in budgetary expenditures on the NDIS, defence and hospitals and medical benefits and the rest are tracking relative to forecast will be an important determinant of the budget bottom line over the medium term.

5. Meanwhile, an often-heard criticism of Australia’s budgetary policy on the revenue side has been growing reliance on the interaction between income tax and bracket creep to support revenue growth. In his speech this week, the Treasurer sounded a little defensive on the broader point around taxes, saying, ‘Some wrongly predict the tax‑to‑GDP ratio will go up this year, when Treasury expects it to be stable or even a bit down.’ But – once again – the Budget will almost certainly fail to deliver any fundamental change on tax.
6. Finally, one last thing to keep in mind is the growing gap between the underlying cash balance and the headline cash balance. Typically, budget reporting focuses on the former. But in recent years there has been a growing divergence between the two concepts. The difference equals so-called, ‘Net cash flows from investments in financial assets for policy purposes’ which captures the impact of policy decisions that are funded not by direct government payments but instead by alternative financing measures including equity investments, loans, and guarantees. The use of these alternative financing mechanisms has grown more important over time, making the underlying cash balance a less comprehensive measure of the overall fiscal position. Examples in recent years include government equity injections and loans in NBN Co, the increased issuance of student loans and a big one-off investment in Snowy Hydro Limited, all of which have produced significant negative net cash flows from investments. More recently still, expenditure relating to the Future Made in Australia program, the Whyalla Steelworks rescue package and the write-down of student debt will show up here.

Readers can find more commentary on the upcoming budget in the linkage roundup below.

Putting Australia’s fiscal numbers into international perspective

Before we move on from budget matters, it’s worth putting some of Australia’s fiscal numbers into international perspective to provide some context around budget debates. These comparisons do note make a case for the status quo. But they do suggest that, when viewed in relative terms, our position is not as dire or dramatic as some budget commentary occasionally suggests. Take three broad comparisons.

First, the scale of the government debt burden. While it is true that Australia’s net debt burden has risen notably in absolute terms since the global financial crisis and the COVID-19 pandemic (see the chart in the previous section), it is also the case that in relative terms our debt as a share of GDP remains relatively modest compared to many of our advanced economy peers. For example, IMF data show that on both a gross and a net basis, Australia’s general government debt burden is still comfortably below the advanced economy average and far below that of many of our peers.

Second, there is a broadly similar story to tell when it comes to the size of government relative to the economy. Again (as we’ve noted here in relation to the Q4:2024 national accounts), recent years have brought a marked increase in the size of the public sector footprint, reflected for example in a sharp rise in the share of public final demand in GDP.

But a look at IMF data on advanced economies shows that the size of Australia’s general government expenditure relative to the size of our economy is still below the advanced economy average. (Some sharp-eyed observers might look at the accompanying chart here and worry that the absence of Singapore and Hong Kong from the country line-up – although they are included in the average – serves to flatter Australia’s relative position. But the decision to exclude the two city ‘states’ from the chart for display purposes also involved the similar exclusion of other small economies including Cyprus, Iceland, Luxembourg and more, all of which have significantly larger government expenditure shares in their economy than Australia.)

The point here is certainly not that Australia should have a larger share of government expenditure relative to GDP than it currently does, or even that the current ratio is optimal. Rather, it is that if Australia were to actively decide that it wanted to have the current ratio of government spending to the economy (or even a larger one), that need not put it out of line with most other advanced economies. Likewise, it need not imply a tax burden that is disproportionately high relative to that same peer group.

The third and final comparison relates to how Australia chooses to finance that government footprint in terms of the tax mix. Although the level of Australian taxation as a share of GDP does not look out of line with the OECD average (it is a little below it), the mix of taxation does look quite different to the OECD average. Australia is much more reliant on taxes on income, profits and gains than most other OECD members and much less reliant on taxes on goods and services. It is this discrepancy that underpins the call from many economists and international observers (including the OECD and the IMF) to rebalance our tax system away from its current reliance on income and company tax and towards a greater reliance on the GST.

The critical point here, then, is that the same level of taxation can have quite different implications for economic performance, to the extent that it can reflect different tax mixes.

Finally, note that another significant difference from most OECD members is that Australia collects no revenue from social security contributions. The latter raise close to nine per cent of GDP in revenue on average across the OECD.

Employment fell sharply in February 2025

The ABS Labour Force release for February 2025 reported a large drop in employment over the month. According to the Bureau, the number of people in employment slumped by 52,800 (seasonally adjusted). Full-time employment fell by 35,700, while part-time employment decreased by 17,000. The ABS highlighted fewer older workers returning to work in February and pointed to recent data showing higher levels of retirement in Australia. The employment to population ratio dropped by 0.4 percentage points to 64.1 per cent and the participation rate also fell by 0.4 percentage points to 66.8 per cent.

The decline in employment came as a surprise to the market, where the consensus forecast had expected the economy to add another 30,000 jobs last month.

Hours worked over the month were also down, dropping by 0.4 per cent in line with the decline in employment.

Despite that decline, the parallel fall in the participation rate (which reflected falls in the number of unemployed as well as the number of employed) left the unemployment rate unchanged in February at 4.1 per cent. This time, that was in line with the consensus forecast. Meanwhile, the underemployment rate fell by 0.1 percentage points to 5.9 per cent. As a result, the overall underutilisation rate was down 0.2 percentage points at 9.9 per cent.

What else happened on the Australian data front this week?

According to the ABS, Australia’s population was 27.3 million at 30 September 2024. That was up 484,000 people (1.8 per cent) over the year, of which 104,200 reflected natural increase and 379,800 was due to net overseas migration. Population growth peaked at more than 660,000 in the September quarter 2023 when net overseas migration was running at more than 555,000.

The ANZ-Roy Morgan Consumer Confidence Index fell 3.1 points to an index reading of 83.8 in the week ending 16 March 2025. All five subindices were also lower over the week. The decline took the index down to its lowest level since October last year as the impact of ex-Tropical Cyclone Alfred helped push down Queensland confidence. ANZ also reckons global trade uncertainty could be weighing on national confidence. Meanwhile, weekly inflation expectations rose 0.1 percentage point to 4.8 per cent.

The ABS published tourism labour statistics for the December quarter 2024. There were 713,500 tourism jobs in the quarter, accounting for 4.4 per cent of all filled jobs in the economy. The number of tourism jobs was up 3.4 per cent over the quarter and 2.5 per cent over the year.

The ABS said there were 710,040 short-term visitor arrivals in January 2025 and 2,383,330 total arrivals.

Other things to note . . .

• Treasurer Jim Chalmers reckons Ex-tropical Cyclone Alfred could deliver an immediate hit to GDP of up to $1.2 billion, wipe a quarter percentage point off quarterly growth and put upward pressure on inflation. He also said that while Treasury has estimated that the direct hit to Australian GDP from the Trump administration’s steel and aluminium tariffs would be less than 0.02 per cent by 2030, the indirect effects of tariffs could be much larger, at closer to 0.1 per cent. Overall, Chalmers said Treasury estimates the indirect impacts of a trade war could be up to four times greater than the direct effects of tariffs on the economy.
• The latest Deloitte Access Economics’ Budget Monitor predicts that after delivering an underlying cash balance in surplus to the tune of $15.8 billion (0.6 per cent of GDP) in 2023-24, the budget will shift into a deficit of $26.1 billion (0.9 per cent of GDP) in the current fiscal year before the deficit widens again to $49.6 billion (1.7 per cent of GDP) in 2025-26. One key driver of that fall into the red is a predicted $11.3 billion downgrade to budget revenues over four years. A second is rising spending pressures across health, aged care, the NDIS and defence.
• And in the AFR, Chris Richardson presents an audit of federal finances. He argues that Australia’s fiscal health is in structural decline and that governments have wasted past budgetary good fortune by using temporary revenue gains to backstop permanent spending increases; avoided any serious reform of an increasingly dilapidated tax system and failed to prepare us for expensive challenges looming in the future. Richardson also reckons both the incumbent government and the opposition are largely in lockstep when comes to budget policies, at least in the near term, noting that over the next four years, the difference between both sets of policies will be less than one per cent of projected tax and spending.
• RBA Assistant Governor (Economic) Sarah Hunter gave a speech on Monetary Policy focussing on three key inputs to the decision-making process. These were how changes in the cash rate affect the economy; how the RBA forms and then updates its baseline forecast of the economic outlook and how the Board deals with setting policy under uncertainty. One point worth noting here is the estimate that while it takes about nine months for the cash rate to have its biggest impact on GDP, the peak effect on inflation takes twice as long to arrive. It follows that any decisions the RBA makes today would have their largest impact on activity at the end of this year and on inflation in mid-2026.
• The chair and deputy chair of the Productivity Commission say Australia should avoid imposing retaliatory tariffs in response to US trade measures, arguing they would increase the risk of a damaging spiral of measures and counter-measures. Instead, Australia should continue to make the case for free trade, while also avoiding the use of any non-tariff retaliation (such as subsidies, anti-dumping measures or local content rules).
• John Quiggin on how the Australian economy has changed since 2000.
• An ABS spotlight on long-term trends in Australia’s participation rate.
• The Economist magazine’s Free Exchange column reckons ‘labour shortages’ don’t really exist.
• Also from the Economist, Europe thinks the unthinkable on a nuclear bomb.
• Germany embraces military Keynesianism.
• The IEA on the outlook for the global oil market.
• In the LRB, Paul Taylor on AI Wars. This BIS Paper provides a detailed look at the complex AI supply chain.
• The WSJ’s Greg Ip considers how Europe comes to life as the US stumbles.
• A look at the role of government subsidies in international trade.
• The FT’s Martin Wolf on the possibility of a Mar-a-Lago Accord.
• Also from the FT, have humans passed peak brain power?
• Could conquest return?
• On the rise and fall of the Hanseatic League.
• The Ezra Klein Show podcast talks to the FT’s Gillian Tett about the Trump administration’s economic approach.
• And the Conversations with Tyler podcast talks with Ezra Klein about the Abundance Agenda. There is a somewhat approving Economist review of Klein’s (co-authored) new book here. See also this review of the Abundance doctrine.