Here's why it's so important Scott Morrison gets his commodity price forecasts right

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Nowhere has the acute volatility of 2016 been more evident than in global commodity markets. Whether it is crude oil, iron ore, coal, copper, aluminium, gold and other commodity markets important to Australia and Australian GDP.

It’s a volatile world and the outlook remains clouded for commodities going forward.

That’s an issue for federal treasurer Scott Morrison and his advisers from Treasury as they frame their price and revenue expectations for the budget over the course of the next, and subsequent financial years.

Michael Blythe, the Commonwealth Bank’s chief economist, highlighted the importance of getting these forecasts right in a budget preview note to clients.

Blythe said:

The linkages are quite clear. In Australia, commodity prices drive the swings in the terms-of-trade. The terms-of-trade drive the cycle in nominal GDP growth. And since nominal GDP is effectively the tax base, government revenue outcomes lie at the other end of the commodity-price chain.

But Blythe also included a chart in the note that shows just how wrong forecasters generally, not just the Treasury boffins, have been in recent years in their expectations about when and where the crash in Australia’s terms of trade would turn around.

That helps explain why the budget is in a much weaker position than had been previously forecast.

“Falling commodity prices are responsible for the weakness in tax revenues. And commodity price forecast errors explain much of the forecast error in tax collections,” Blythe wrote.

That, he says, means the market will be focused on treasurer Morrison’s assumptions with “the key to evaluating risks to Budget projections on the night will be to stress test the underlying commodity price assumptions”.

But it could be enough for Australia’s terms of trade to simply stop falling, Blythe says, for the outlook to improve materially.

“Our own stress testing shows that the terms-of-trade just has to stop falling to change the income dynamics. A flat terms-of-trade from end 2015 levels would see income growth bounce back from 2% in 2015 towards 5%pa by 2017 (all else equal),” Blythe said.

We’ll know more at 7.30pm AEST tomorrow.

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