One of the world's largest banks has slashed its iron ore price forecasts, warning Australia's ballooning budget deficit is set to get even worse.
JP Morgan economists have trimmed their price forecasts for 2015 and 2016 by up to 30 per cent, with iron ore now expected to fall as low as $US43 per tonne within the next six months.
It's not as dire as some forecasts, with Citi predicting prices for Australia's biggest export will fall to about $US37 this year, but it would still deliver a massive blow to the federal budget bottom line.
JP Morgan estimates that Treasurer Joe Hockey will have a $45 billion deficit on his hands in 2014/15, with a $35 billion deficit to follow by the end of 2015/16.
That's about $5 billion worse per year than Treasury's forecasts in the mid-year budget update in December, which were based on an iron ore price of $US60 a tonne.
"It looks like revenues are going to be somewhere in the vicinity of $6 billion lower, purely due to iron ore," JP Morgan economist Tom Kennedy said.
"That means one of two things has to happen: one, you get larger deficits; or two, you get further saving measures, further cost cutting.
"We don't think the latter of those two will happen, we don't think Hockey is going to go out there and try and chase these savings, so you'll see larger deficits."
If iron ore prices do fall as steeply as JP Morgan expects, Australia's terms of trade - the ratio of export prices to import prices - could drop 16 per cent from last year.
That increases the risk that the Reserve Bank will need to take interest rates into unchartered territory below two per cent, JP Morgan said.
Iron ore prices have fallen by more than 60 per cent in just one year.
They climbed back above $US50 a tonne overnight, having plunged below $US47 over the Easter weekend - a far cry from $US135 at the start of 2014 or $US185 in 2011.
Treasurer Joe Hockey earlier this week said the federal government was contemplating a fall to $US35 a tonne, because "there seems to no floor" in the cycle, leaving federal coffers $25 billion short over the next four years.
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