Good signs amid week's shock and horror

A shock bank tax, dramatic dollar dive and horror mini-budget notwithstanding, this has been a pretty good week for long-term investors.

First, the bank levy. It's a budget fiddle because the money raised will be an accounting entry that bulks up budget revenue, but it will also be set aside to support the government's guarantee on retail deposits up to $250,000.

It's not a perfect user-pays structure, because the banks might not pass the charge straight through to deposits. They could lay it off in other places too, including their lending rates, and their decisions will, as always, be influenced by how heavily they are competing.

It is a system backed by the top financial regulators, however, and while it might carry some political risk for the Rudd government, it will not devastate bank profits. The 0.05 per cent levy will raise $733 million in the 18 months after its introduction in January 2016, and the four big banks increased their statutory profit by 11.7 per cent to $18.1 billion in the first half of their current financial year.

Arguments that a levy is not needed in this country ignore the fact banks are ramping up deposits in their funding mix as part of a worldwide regulatory push. Over-reliance on short-term debt was their key weakness in the financial crisis, and a deposit levy is a logical way for the government to charge a retail deposit insurance premium.

The mini-budget the government released on Friday also does not materially change the investment goalposts.

A $33.3 billion four-year slide in tax collections combined with measures including early termination of the carbon tax ($3.8 billion) and other changes to push the forecast deficit for this financial year from the May budget's prediction of $18 billion to $30.1 billion, and the 2014-15 budget deficit from $10.9 billion to $24 billion. The budget's estimate of an $800 million surplus in 2015-16 is replaced with an estimate of a $4.7 billion deficit, followed by a surplus of $4 billion the following year.

Savings of $17.4 billion between this year and 2016-17 as expected include four separate 12.5 per cent a year hikes in tobacco taxes ($5.8 billion), a crackdown on novated leasing ($1.8 billion) and the bank levy.

The government is also increasing its public service efficiency dividend target from 2 per cent to 2.25 per cent ($1.8 billion over three years), increasing the threshhold for lost superannuation to be transferred to the Australian Tax Office from $2000 to $4000 in December 2015 and from $4000 to $6000 in December 2016 ($582 million), and slowing the growth of foreign aid ($879 million).

The mini-budget does not upset the consensus on both sides of the political divide for relatively tight fiscal policy, however.

It is a strategy that has its critics - visiting Citigroup chief economist Willem Buiter confessed this week to being bemused by what he called a surplus of fiscal virtue in Australia, and on Thursday National Australia Bank chief executive Cameron Clyne (pictured) said the government was ignoring a unique opportunity to raise AAA-rated debt to fund long-term infrastructure development and renewal - but it is also a strategy that is entrenched.

That means the weight will stay on the Reserve Bank to provide enough stimulus to offset fiscal tightness and lift the non-resources economy as Australia's resources sector investment boom fades, and the news on that front this week was encouraging.

The Reserve Bank cut its cash rate from 4.75 per cent to 2.75 per cent between October 2011 and May, and Reserve Bank governor Glenn Stevens said on Tuesday that the central bank saw no "serious impediment to further easing". He also spoke more guardedly than in the past about the ability of the non-resources sector to fill the growth gap created by a retreating resources investment boom.

The market's verdict after the speech was that a cash rate cut is a certainty when the Reserve meets next Tuesday, and that another cut later this year is possible.

The dollar was at US91.6¢ before Stevens spoke. It was just above US89¢ on Friday afternoon and has fallen by 15.6 per cent since mid-April, delivering stimulus that buttresses the Reserve Bank's rate cuts.

The news overseas this week has been good, too. The US markets rallied on news that manufacturing activity expanded at its fastest pace in two years. Labour market data for the US was also strong, and manufacturing indices in Britain and Europe rose, supporting a glass-half-full view that Europe may finally be climbing out of the recession caused by the global crisis and the European sovereign debt crisis.

The bank of England, European Central Bank and US Federal Reserve left their key interest rates at record lows - that also helped push our $A down - and the Fed did not set a firm date for the first incremental retraction of its $US85 billion-a-month quantitative easing program.

The US economy looks strong enough to persuade the Fed to begin retracting QE next month as the market expects, although it's worth noting that in its post-meeting statement the Fed did sound out some concern that inflation in the United States is now too low.

None of this should prompt a sharemarket leap. The US holiday season is drawing to a close, and that in the past has seen momentum shift, but both the US and Australian sharemarkets are not cheap.

Australia's S&P/ASX 200 share index has moved from a price-to-earnings multiple of 12.1 times expected earnings a year ago to about 14.2 times expected earnings, close to its 10-year average. After a 5 per cent gain in July, Wall Street's Standard and Poor's 500 Index was trading at 15.5 times expected earnings on Thursday, well above its five-year average of 13.9 times.

Investors in both markets are anticipating earnings that are yet to come, in other words, but that is not unusual. When economies are showing signs of recovering, share prices rise in the belief that earnings increases will follow.

Will the profits be delivered? Still too early to say - but despite all the shock, horror and drama this week, the odds on economic recovery here and overseas are better now than they were when the week started.

mmaiden@fairfaxmedia.com.au