What the federal budget means for interest rates and ASX shares

Some ASX shares will benefit more than others from the new Federal budget.

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ASX shares are broadly enjoying a strong run on Wednesday on the heels of the Federal government's budget announcement.

In early afternoon trade today, the S&P/ASX 200 Index (ASX: XJO) is up 0.5%.

Not surprisingly, given the multi-billion dollars of new support for ASX shares focused on renewable energy and critical minerals, the S&P/ASX 300 Metals & Mining Index (ASX: XMM) is outperforming, up 1.4%.

With the budget potentially fuelling inflation and pushing interest rate relief from the RBA further into the future, ASX financial shares are among the weaker performers, with the S&P/ASX 200 Financials Index (ASX: XFJ) up just under 0.1% at this same time.

Here's what's happening.

Will the budget fuel inflation and push out interest rate cuts?

Investors in ASX shares may wish to position their portfolios for higher rates for longer.

With the Federal budget adding an additional $24 billion to the Aussie economy over the next four years, inflation could rekindle.

Treasurer Jim Chalmers has crafted the budget with hopes it will help reduce price rises. As such, Aussie households will receive energy relief in the form of a $300 power bill rebate, to be delivered quarterly. This comes atop the next stage of tax cuts.

"Just as every Australian taxpayer will get a tax cut, every Australian household will get energy price relief," Chalmers said.

However, the budget itself assumes the RBA will only begin to "gradually ease" the official cash rate from the current 4.35% "around the middle of 2025". The government expects the cash rate to still be at 3.6% in mid-2026.

But Judo Bank economic advisor Warren Hogan has a far more hawkish outlook, believing investors in ASX shares should prepare for further interest rate hikes rather than cuts in the wake of the Federal budget.

According to Hogan (quoted by Sky News):

I do think they have shown some restraint. I think many Australian governments in the past might have spent more like $20 billion on new measures, but they've only done $10 billion. That might mean we only need one or two rate hikes, but it doesn't change the underlying story about the economy.

I think there is a very strong chance the RBA might have to raise rates again.

AMP's chief economist Shane Oliver noted that, "The cost-of-living measures will help lower measured inflation. But the new stimulus risks boosting demand."

Oliver added:

Government support for high wage increases for some sectors risks adding to wages growth given the flow on and influencing effects at a time when wages growth is already at its maximum level consistent with the inflation target. All of which risks making the RBA's job harder.

Putting all the Federal budget pieces together, Oliver said, "The net effect adds to the risk of higher for longer interest rates but is probably not enough to change our forecast for a rate cut later this year."

As for the ASX shares that stand to benefit…

What the budget means for ASX shares

ASX shares in the critical minerals space and those involved in green hydrogen and renewables could be set to benefit from the government's $22.7 billion Future Made in Australia (FMIA) plan.

FMIA will provide $13.7 billion in tax incentives for green hydrogen and processed critical mineral production. There's also $1.7 billion to drive innovation in producing green iron and other metals along with low-emissions fuels.

ASX shares that could potentially benefit from the billions in new funds due to their exposure to subsidised metals include Fortescue Metals Group Ltd (ASX: FMG), BHP Group Ltd (ASX: BHP), Pilbara Minerals Ltd (ASX: PLS), IGO Ltd (ASX: IGO) and Liontown Resources Ltd (ASX: LTR).

The tax cuts and energy relief will also put more money back into consumers' pockets.

That should offer some welcome tailwinds for ASX shares in the retail space such as JB Hi-Fi Ltd (ASX: JBH) and Harvey Norman Holdings Ltd (ASX: HVN).

And ASX shares like Domino's Pizza Enterprises Ltd (ASX: DMP) could enjoy a lift as lower-income households reopen their pocketbooks.

Commenting on what the overall impact of the budget will be for ASX shares, AMP's Oliver said, "The budget is positive for spending and hence retail shares, but this may be offset by higher than otherwise rates. Some manufacturers may benefit from FMIA."

Motley Fool contributor Bernd Struben has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Domino's Pizza Enterprises. The Motley Fool Australia has positions in and has recommended Harvey Norman. The Motley Fool Australia has recommended Domino's Pizza Enterprises and Jb Hi-Fi. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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