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Budget Policy Statement 2012

Economic Outlook

The Treasury is responsible for the preparation of the following overview of its latest economic forecasts, which represent a refresh of the Pre-election Update and have been used to support the Budget Policy Statement.  Although not a full economic and fiscal update, the economic forecasts are the Treasury's current view of the outlook and have been used to update taxation revenue, welfare benefit expenditure and finance cost forecasts.

The Pre-election Update outlined the five major forces we saw influencing the path of the economy over the 2011/12 to 2015/16 forecast horizon: the global economy, particularly economic and financial developments in Europe; commodity prices; the rebuilding of Canterbury; the degree of household saving; and the withdrawal of monetary and fiscal stimulus. The discussion below outlines the judgements around the impact of each of these forces and how they have changed since Pre-election Update was prepared.

Table A3 - Updated economic forecasts*
March Years 2011
Real GDP (annual average % change) 1.2 1.9 2.8 3.8 3.1 2.6
Unemployment rate (March quarter, s.a.) 6.6 6.2 5.7 5.1 4.9 4.6
CPI inflation (annual % change, March quarter) 4.5 2.0 2.0 2.3 2.4 2.5
Current account balance (% of GDP) -3.6 -4.1 -4.8 -6.5 -6.9 -6.9

* Forecasts finalised 19 January 2012

Sources: The Treasury, Statistics New Zealand

Global growth prospects have weakened...

Figure A1 - Top-16 trading partner growth
Figure A1 - Top-16 trading partner growth.
Sources: IMF, The Treasury

Global growth prospects have weakened further since the Pre-election Update was released in October and the risks to global stability from the European debt crisis have intensified. To date, the downward movement in the outlook, although significant, is well short of the lower trading partner growth forecasts assumed in the downside scenario in the Pre-election Update.

The euro area has been the main driver of the weaker global outlook. Continuing sovereign debt concerns, particularly around Greece but also for larger economies such as Italy, have increased global risk aversion. Bond yields in riskier countries have become elevated, raising concerns about the sustainability of government finances and the impact on banks. The central case is that the euro area remains intact and manages through the crisis but with a recession this year now expected. There are also signs of slower growth and lower forecasts elsewhere, including China and other parts of Asia.

...and will impact the New Zealand economy...

Global developments are expected to be a drag on New Zealand's growth relative to the Pre-election Update. The degree to which global events affect New Zealand will depend on the severity of the decline in international growth and financial market disruption. The main channels (and impacts) are:

  • Confidence, which has so far been relatively resilient to recent global developments. Nevertheless, confidence measures have generally fallen and are expected to result in lower growth in consumption and investment in the near term than previously expected.
  • Terms of trade. World export prices for New Zealand's commodity exports are down 9 per cent from a peak in May 2011. While prices for food products are expected to be underpinned by demand from emerging markets, further falls are forecast, owing to weaker global demand. Together with oil prices holding up, owing to threatened supply restrictions, the terms of trade are now expected to weaken sharply in 2012 from recent historically high levels.
  • Export demand. Commodity export volumes are currently benefitting from strong agricultural production as a result of good growing conditions. However, non-commodity exporters, such as manufacturers and tourism operators, will not fare as well as previously expected with weaker global demand and a relatively high exchange rate.
  • Funding costs. New Zealand banks' ability to source funds from overseas has become more difficult and expensive as a result of a global re-rating of bank riskiness. Banks are reasonably well funded at present and with credit demand quite muted, there has been little impact on lending. We assume bank funding costs over the next year will be higher than previously assumed. If bank funding pressures intensify we would expect to see more impact.

...but how the other key drivers of the outlook evolve is also important

Earthquake-related rebuilding is expected to provide substantial impetus to economic activity in coming years, even though recent aftershocks are likely to delay some rebuilding by 1 to 2 quarters. We continue to assume earthquake damage to property, contents and infrastructure of around $20 billion in today's prices, with only modest additional damage from the earthquakes since 23 December 2011. Total costs, including business disruption or additional costs from inflation, insurance administration or rebuilding to higher standards than existed before the earthquakes, will be higher than this at around $30 billion.

Household saving became positive (0.2 per cent of household disposable income) in the March 2011 year for the first time since 2000 and only the second time since 1993. Household saving is expected to continue increasing over the forecast period. Uncertainty about global developments and their impact on New Zealand could see additional saving. Firms may also be more cautious about growth prospects and delay some employment and investment plans.

Monetary conditions are expected to gradually become less stimulatory as interest rates rise to keep inflation in check. However, interest rates have fallen since the Pre-election Update with the weaker outlook, offshore issues and a fall in CPI inflation to 1.8 per cent in the year to December 2011. The exchange rate had fallen in line with higher global risk aversion and lower commodity prices, although has rebounded in early 2012. Easier monetary conditions, if sustained, will provide some additional support to growth.

Outlook weaker for 2012/13

Economic growth in the second half of 2011 appears to have developed broadly in line with the Pre-election Update forecasts in 2011. Economic growth in the September 2011 quarter of 0.8 per cent was marginally lower than the 0.9 per cent expected in the Pre-election Update. However, revisions to previously published data mean the recovery has been weaker than previously thought and has affected annual growth rates. Growth in the March 2011/12 year is expected to be 1.9 per cent, down from 2.3 per cent in the Pre-election Update.

Figure A2 - Real production GDP
Figure A2 - Real production GDP.
Sources: Statistics New Zealand, The Treasury

On balance, we expect real GDP growth for New Zealand will be lower in 2012 than in the Pre-election Update, leading to growth in the 2012/13 March year of 2.8 per cent rather than 3.4 per cent. We see particular risk around the first half of 2012 as it falls between the positive impacts from the World Cup in late 2011 and the assumed ramp-up of rebuilding in Canterbury from late 2012.

Growth is then expected to be higher in the 2013/14 March year than previously expected, owing to the later rebuild and a more general recovery in the economy in line with an assumed rebound in trading partner growth. An easing of growth towards 2½ per cent is expected by the end of the forecast period.

The Consumers Price Index (CPI) rose 1.8 per cent in the year to December, well below the Pre-election Update forecast of 3.1 per cent, as food and travel prices fell sharply. Weaker economic growth will also contribute to softer near-term inflation. A strengthening in the economy is expected to reduce spare capacity and put upward pressure on inflation. An assumed depreciation of the exchange rate lifts inflation towards the end of the forecast period.

The unemployment rate was 6.6 per cent in the September quarter, compared with 6.3 per cent in the Pre-election Update but wages and hours worked were stronger. The weaker economic outlook in 2012/13 is expected to flow through to a slower improvement in labour market conditions.

The annual current account deficit is expected to be larger than we expected in the Pre-election Update in the short term, owing to the terms of trade not peaking as high and higher income outflows (eg, bank profits). In the medium term, the deficit rises above 6 per cent of GDP, as previously expected, owing partly to the increase in investment associated with the rebuilding in Canterbury. As the rebuilding in Canterbury winds down, and assuming the exchange rate depreciates as in these forecasts, the current account deficit would be expected to return to more sustainable levels of around 4 per cent of GDP.

Risks are still large

Risks to the economic outlook remain skewed to the downside. In particular, there is a possibility of much worse outcomes for the euro area, which could lead to the global economy moving back into recession. Domestically, further seismic activity in Christchurch could push rebuilding activity back further and/or reduce the overall level of reinvestment that takes place. Other risks remain, including changes in weather conditions or changes in other important trading partners' economies.

With high levels of uncertainty about the outlook, volatility in financial markets is likely to remain a feature of the coming year. We continue to expect bouts of relative optimism and pessimism as policymakers attempt to convince markets they have the euro debt crisis and other threats to global stability and growth under control. This also means that economic forecasts could be subject to large changes within short periods of time. A full Economic and Fiscal Update will be provided with Budget 2012.

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