Iron ore above $US100 to deliver budget windfall next year

“Their forecasts are so low – iron ore is forecasted at a price which it has not gone down to in seven years – it has been this constant budget windfall,” Perpetual head of investment strategy Matt Sherwood said in an interview. “Those prices are incredibly conservative when they don’t need to be.”

UBS published a report on Wednesday that forecast the price of the key steel-making ingredient to trade between $US100 a tonne and $US135 a tonne over the next 24 months, citing limited supply and further economic stimulus from Beijing.

“Over the medium term, coupled with moderating supply growth and robust steel export demand, there is upside risk to our price forecasts in 2025-26 if Chinese steel exports hold at healthy levels,” UBS wrote in a note to clients.

Record highs

The strength of iron ore prices, currently near $US135 a tonne, also propelled Rio Tinto and Fortescue to share price highs on Wednesday.

“I see significant upside potential to the budget balance,” Mr Sherwood added. “Each $10 per tonne increase above [the Treasury’s] estimate adds about $500 million of revenue to the budget balance – a surplus this financial year is my base case.”

National Australia Bank head of market economics Tapas Strickland also said the headline deficit of $1.1 billion would eventually turn into a surplus, citing the Treasury’s use of “fairly conservative” budget assumptions of commodity prices.

“The main reason is the government seems to be banking most of the revenue gains it has seen from inflation and the elevated commodity prices,” Mr Strickland added.

Inflation optimism

He described the MYEFO update as generally positive for the economy, adding that there were little implications for the Reserve Bank’s battle against inflation.

“The government’s fiscal stance is broadly neutral,” he said. “In order to help the RBA in its inflation fight, you want to see a more sizable surplus than what is currently projected.”

Economists were also struck by the Treasury’s “more optimistic” view on when inflation will return to the RBA’s 2 to 3 per cent target band.

The inflation forecast remains unchanged with MYEFO predicting the consumer price index to fall to 2.75 per cent next financial year.

“It would imply less risk of another rate hike,” AMP chief economist Shane Oliver told The Australian Financial Review.

“They’re running about 0.25 below where the RBA is on inflation, which suggests that all things being equal, and if the Treasury is right, then there’s less risk of another rate hike and the RBA will be starting to cut rates sooner,” he said.

Bond futures indicate Australia’s cash rate will remain on hold at 4.35 per cent for most of next year. They imply only an 8 per cent chance of a rate rise at the first policy meeting in February, and are fully priced for the first rate cut by December.

BIS Oxford Economics’ Sean Langcake said overall that the Treasurer had taken a “do-no-harm” approach amid a high inflation environment.

“There was no big kind of handouts to households that would then go on to fuel inflation. Equally, there’s no additional cost-of-living relief,” Mr Langcake said.

“I don’t think there’s anything there that necessarily takes pressure off the RBA with the inflation outlook, but equally they’ve done a good job of avoiding anything that heaps more pressure on,” he said.