Australia's mid-year budget update: here's what Aussies need to know

Australian Treasurer Jim Chalmers updated the Mid-Year Economic and Fiscal Outlook on Wednesday, which includes updates on issues such as the budget deficit and economic growth forecasts. So, what are the key takeaways from this report, how will these updates affect the Australian stock market, and how should Australian investors adjust their trading strategies? We will discuss these points in detail below.

Economic growth: Due to the current high interest rates, private sector economic activity has been subdued. The Treasury has downgraded its economic growth forecasts for both the current fiscal year and the next. The growth projection for the current fiscal year ending in June 2025 has been revised down from 2.0% in last year's budget report to 1.75%.

Budget deficit: Due to increased government spending and weaker-than-expected economic recovery in Australia's major trading partner, China, the Treasury forecasts that Australia's budget deficit will widen in the coming years. The deficit for the current fiscal year is expected to narrow slightly to A$26.9 billion, but by 2025-26, the budget deficit is projected to rise to A$46.9 billion, or 1.6% of GDP, and remain above 1% of GDP in the following two years.

Inflation and unemployment: The Treasury expects the overall inflation rate to remain within the RBA's target range of 2-3%, reflecting the impact of energy rebates and other subsidies. As for the core inflation rate, which is of greater concern to the central bank, it currently stands at 3.5% and is not expected to fall within the target range until the end of 2025. Despite higher interest rates, the unemployment rate has remained at very low levels, and it is projected to rise from 3.9% in November to 4.5% by June 2025. "We are trying to manage a soft landing on a bumpy runway," Mr Chalmers told reporters in Canberra. "We know that the global economic environment is very difficult, we know that people are still under cost-of-living pressure, we know that interest rates are still having an impact on the economy."

Iron Ore prices: China is Australia's largest trading partner in terms of both imports and exports of goods and services for the 2023-24 fiscal year. Jim Chalmers stated on Monday that, due to weaker-than-expected economic recovery in China, Australia has revised its mining export revenue forecast down by more than A$100 billion over the next four years. The report released on Wednesday mentioned that iron ore prices are expected to fall to around US$60 per tonne by September 2025, down from the current level of approximately US$100 per tonne.

As economic growth is a key driver of corporate profits and stock market performance, the downward revision of growth expectations could have a negative impact on the Australian stock market. However, concerns over economic slowdown may prompt the RBA to adopt a more dovish stance, with the market bringing forward expectations for interest rate cuts in the coming year, which could help boost market sentiment and stock performance. As for the sectors, in the current high-interest rate environment, net interest margins for banks may face further compression as economic activity slows. This could dampen profitability in the banking sector. Also, due to the weaker-than-expected economic recovery in China, iron ore demand may continue to decline, putting further pressure on iron ore prices and potentially affecting the profitability of Australian mining companies.

Unlike the Australian market, the U.S. economy remains resilient. Current data suggests that despite some cooling in the labor market, there are no clear signs of an imminent recession. Furthermore, a series of tax cuts and deregulation measures introduced under the Trump administration are expected to support the U.S. economy. Therefore, Australian investors may consider focusing on companies with significant exposure to the U.S. market, thereby benefiting from the robust performance of the U.S. economy through investing in Australian companies. Below are some Australian companies with strong U.S. business exposure, as compiled by Morgan Stanley and Macquarie.