State budgets and economies at risk from increasing interest rates

Wages growth would be slower while inflation in Sydney would be about a half percentage point lower.

“Overall, this means consumers will spend less and businesses will invest less, leading to a reduction in domestic economic activity and, consequently, lower employment,” it found.

“Falling aggregate incomes will further reduce demand growth and decrease inflationary pressures. Weaker domestic investment leads to relative falls in employment, an increase in the unemployment rate, a decrease in capital utilisation and consequently weaker wage and price pressures.”

EY chief economist Cherelle Murphy said all states were facing a difficult task trying to determine the actual path of interest rates and getting it wrong could cost billions of dollars.

“This year, state treasuries need to consider the impact of higher than expected interest rates. It’s one of many variables that can knock the budget off course,” she said.

“The impact of higher rates can be substantial. As the NSW budget papers point out, if interest rates are on average one percentage point higher than baseline forecasts for a three-year period from September 2022, its revenue will be $2.7 billion lower in 2022-23, $1.6 billion lower in 2023-24 and $1.4 billion lower in 2024-25.”

Higher interest rates would not only slow the economy but also undermine the state budget. Borrowing costs on state debt are growing faster than had been expected as global markets price in much higher levels of inflation.


The Victorian Treasury estimates that if interest rates are one percentage point higher than assumed, its interest costs would be almost $300 million higher in 2022-23. By 2025-26, the state’s interest bill would be almost $1.2 billion more than forecast.

That would translate into state net debt being $2.1 billion higher in 2025-26 than forecast in the recent budget.

The West Australian Treasury also noted that if interest rates on state government debt was higher than expected, then there would be a cost to that state’s taxpayers.

It estimated the WA interest bill would be $169 million a year higher by 2025-26 if the average effective interest rate on state debt was 0.73 percentage points above expectations.

In NSW’s case, the budget would not return to surplus until 2025-26 while overall debt would be higher.

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