The Reserve Bank will reluctantly slash interest rates again, as the government's ballooning budget deficit forces the central bank to do the heavy lifting in stimulating Australia's sluggish economy, a leading economist says.
Goldman Sachs chief economist Tim Toohey expects the budget deficit to come in at $48 billion this year but says monthly Treasury figures suggest that number could balloon to $55 billion.
Most of that damage comes from the government's inability to get savings measures through the Senate, he said.
The deficit for 2015/16 is expected to be $43 billion - $12 billion worse than the government's mid-year forecast.
The significant deterioration makes it likely that Australia will be put on negative watch by credit rating agencies in coming months, Mr Toohey said, with a downgrade to the nation's prized triple-A rating likely to be a "line-ball decision".
He expects the Reserve Bank will reluctantly slash Australia's official interest rate to a new historic low of 1.75 per cent this year, with sluggish economic growth forcing the central banks's hand.
What the economy needs, and what the RBA has pushed for, is government stimulus to lift growth out of the doldrums in the wake of the mining boom, Mr Toohey told reporters on Thursday.
But the government's own narrative and the promises it took to the election, as well as the increasing risk of a ratings downgrade, prevented them from doing that, he said.
"Economic orthodoxy for the last 20 years has been that debt and deficits are very, very bad and should be removed at all costs," Mr Toohey said.
"They're hamstrung on their ability to do a lot more at the moment and that's why I think the budget will be used as a stepping stone to change the discussion around what can feasibly be accepted by voters in terms of debt and deficit going forward."
Despite the dramatic media headlines, a ratings downgrade would create more political discomfort than financial pain, Mr Toohey said.
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