Treasurer Jim Chalmers vows to cut spending as ex-Treasury economist warns of rate hikes

Treasurer Jim Chalmers insists Labor will be cutting spending as a former Treasury economist warns an expansionary Budget will force the Reserve Bank to hike rates six more times to 18-year-high — risking a recession.

Too much cost-of-living relief during a global oil shock is now regarded as an inflation risk by a range of economists.

Ahead of delivering his fifth Budget, Dr Chalmers vowed to find $64 billion in savings — including redirected spending — to cope with the Middle East conflict fuelling inflation.

“We’ve been able to focus on the particular pressures and developments coming at us from the war in the Middle East — obviously, those are the new bits,” he told Bloomberg TV on Monday.

“We had some inflationary pressures before the war in the Middle East but the war has made them much more substantial.

“That’s why we will be forecasting an increase in inflation, a bit like the Reserve Bank has been forecasting.

“The inflationary challenges are serious, they are a big focus of the Budget — $64b in gross savings is much more than the usual amount of savings in an Australian Budget.”

Dr Chalmers also promised to save the increase in company tax revenue from higher liquefied natural gas prices sparked by the Iran war, with economists expecting it to shrink the size of the Budget deficit.

“We’ll also be banking every dollar of the upward revision to revenue,” he said.

Shadow treasurer Tim Wilson said Labor could not be trusted to restrain its spending.

“The Government is seeking to declare an assault on Australian families and small businesses because they can’t control their spending addiction and their active inflation agenda,” he said.

Former Treasury economist Warren Hogan is warning the Reserve Bank could be forced to hike rates six more times to an 18-year high of 5.85 per cent within 18 months unless the Federal Government was able to restrain annual spending growth to less than 2 per cent in Tuesday night’s Budget.

Government spending is already at a four-decade high, outside COVID, as a proportion of the economy and Treasury’s mid-year update in December forecast spending growth of more than 3 per cent for 2026-27, with big-spending Labor governments in Victoria and Western Australia also adding to inflationary pressures.

“Let me put it to you in the simplest terms: every bit of spending the Government does above 2 per cent real spending growth is going to add rate hikes to what the RBA’s going to do over the next 12 to 18 months,” Mr Hogan told The Nightly.

“This is a time for the Government to be humble — they’re putting extreme pressure on the people of Australia.

“If we don’t see a pivot from our Government at a Federal level away from the strategies of the last four years, they have locked us into a path that will not end well.”

The RBA has already raised rates three times this year to a 15-month high of 4.35 per cent and Mr Hogan, the managing director of EQ Economics, said the cash rate was already likely to hit at least 5.1 per cent before government spending was factored in.

More hikes on top of that, taking it to 5.85 per cent or the highest level since October 2008, risked sparking a recession like the early 1990s.

“They’re going to probably push the RBA to raise rates towards six per cent and that will generate a recession,” he said.

The Federal Budget is expected to include $200-$300 tax offsets on top of $268 in tax cuts already planned for July 1 under marginal tax bracket changes for those earning $18,200 to $45,000.

Labor also faces accusations of breaking an election promise with plans to wind back the 50 per cent capital gains tax discount and negative gearing for property investors in the name of intergenerational fairness.

The move is not expected to raise significant revenue.

“The capital gains tax changes are going to do nothing of note, in my view, to the economy in the short term,” Mr Hogan said.

“They’re not going to take enough money out of people’s pockets or change investment behaviour and decision making enough to alter the course of the overall Australian economy.”

The Middle East conflict has caused a spike in demand for liquefied natural gas, Australia’s third biggest export, after Iran attacked a Qatari LNG plant in March.

This has led to heightened demand for Australian LNG from the likes of Japan, South Korea and Singapore, and is forecast to reduce the size of the Budget deficit for this financial year.

A smaller deficit, however, should not be regarded as a sign of a less expansionary Budget, Mr Hogan said.

“This idea that a Budget deficit is expansionary and a surplus is contractionary is completely misguided,” he said.

Spending a company tax revenue windfall on cost-of-living relief could worsen already-high inflation, Westpac senior economic Pat Bustamante said.

“While there is a clear case for governments to redistribute some of these gains, doing so through a material net expansion in fiscal policy risks leaving the overall stance more expansionary than is consistent with returning inflation to target,” he said.

Westpac is expecting soaring commodity prices to reduce Australia’s Budget deficit for this financial year by $13 billion to $23.8 billion.

That’s a dramatic reduction from a $36.8 billion deficit for 2025-26 forecast in Treasury’s Mid-Year Economic and Fiscal Outlook, as recently as December.

With crude oil prices hovering around $US100 a barrel, motorists face paying more than $2 a litre again on average unleaded petrol, even with fuel excise temporarily halved to 26.3 cents a litre until the end of June.

Inflation in March hit a three-year high of 4.6 per cent during the first full month of the Iran war.

Core inflation, without the volatile items was at 3.3 per cent, putting it well above the Reserve Bank of Australia’s 2-3 per cent target.

There are fears this could rise to 5 per cent too for the time in three years if price pressures intensify beyond fuel.

EY economists warned more government spending to address the flow-on effects of high fuel prices would add to inflation.

“The impact of the Middle East conflict and subsequent rise in oil prices means Australia’s inflation problem has only gotten worse from an already elevated level,” they said.

“Government spending, which is at a record high as a share of the economy, must avoid adding to inflation.

“We know some cost-of-living measures are planned but hope anything further is targeted only to those in need to avoid exacerbating the problem.

“Do not add to spending, unless offsetting it elsewhere.

“Change existing policy to lower spending and find new revenue that will persist over time.”

With government payments expected to make up 27 per cent of gross domestic product this financial year, EY is also warning of higher Federal Government interest payments.

“Higher interest rates and bond yields will lift the cost of issuance and refinancing even higher, increasing debt servicing pressures,” it said.