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Budget 2007 Home Page Budget Economic and Fiscal Update [2007]

Growth Rebounded in Late 2006 and Early 2007

A rebound in some drivers of growth …

Many of the forces which led to the slower growth in the economy in 2005 and 2006, particularly in domestic demand, rebounded towards the end of 2006. Net migration inflows increased, house price growth re-accelerated, petrol prices fell and world prices for some key export commodities increased further. In addition, the labour market and government expenditure have provided continuing support and in aggregate these are outweighing the impact of tighter monetary conditions.

… has seen economic growth re-accelerate and led to a reappraisal of the near term outlook

Real production GDP increased 0.8% in the December 2006 quarter – stronger than the 0.4% increase forecast in the Half Year Update. The expenditure measure of GDP, at 1.2%, increased to an even greater extent, with 3.3% gross national expenditure (GNE) growth. Partial activity indicators point to the pace of growth being maintained in the first quarter of 2007. GNE growth of 4.4% is now forecast for the year to March 2008, compared with 1.7% forecast in the Half Year Update.

Net migration increased in late 2006 …

Figure 1.8 -Consumption and house prices
Sources: Quotable Value New Zealand, Statistics New Zealand, The Treasury

The increase in net migration inflows from their trough of 6,000 in late 2005 to 15,000 in late 2006 contributed to the resurgence in house price growth and private consumption recorded in late 2006 and early 2007. Private consumption expenditure grew 1.1% in the final quarter of 2006, more than in the first three quarters of the year as a whole. Consumption growth is expected to remain solid over the next couple of quarters, lifting annual average growth from 1.7% in March 2007 to 3.2% in March 2008. House price growth has picked up recently and further solid increases are expected until mid-2007, supporting private consumption and encouraging residential investment growth.

… the terms of trade continue to reach new cyclical highs …

The terms of trade increased sharply in the December quarter of 2006, and are expected to increase further during 2007. International dairy spot prices increased 45% in the six months to March 2007, as a result of the drought in Australia and increases in stockfeed prices in the United States, and are likely to remain high through 2007. World oil prices fell 15% in the December quarter of 2006 from their average of around US$70/barrel in mid-2006, and eased a further 3% in March 2007. These developments will support private consumption growth in the near term as lower petrol prices translate into increased household disposable incomes.

… and the labour market remains buoyant

Labour income growth remained buoyant in the second half of 2006, despite a slight fall in employment. Solid labour income growth is expected over much of 2007 as wage growth remains around recent levels and employment levels remain high. These are forecast to support private consumption growth and residential investment in the near term. The increase in Working for Families payments that took effect on 1 April 2007 will work in the same direction by increasing household incomes.

Domestic demand expected to remain solid in 2007, despite higher interest rates …

Ninety-day interest rates increased to around 8.0% in April 2007 as the Reserve Bank increased the official cash rate to 7.75% on 26 April. In addition, local banks have raised their retail mortgage rates for two-year and five-year fixed-rate loans to increase their margins. Interest rates are now expected to be higher for longer than in the Half Year Update, because of the stronger domestic demand and increased inflation pressures that are expected to arise as a result. The increase in interest rates, and the impact of past rate rises progressively being reflected in effective mortgage rates, are expected eventually to dampen consumption and investment demand. However, over the near term other factors (discussed above) are forecast to dominate, resulting in some continued momentum in domestic demand growth in 2007. How long this lasts is a key judgement which is explored in the Risks and Scenarios chapter.

Figure 1.9 - 90-day interest rates
Sources: Reserve Bank of New Zealand, The Treasury

… but the high NZ dollar will limit export growth and increase import growth

Figure 1.10 - TWI exchange rate
Sources: Reserve Bank of New Zealand, The Treasury

The NZ dollar reached a new post-float high of just under US$0.75 in April 2007. At its current level above 70.0 on the TWI, the NZ dollar is well above its estimated equilibrium value and adversely affecting returns to many exporters. Together with robust domestic demand growth, the high dollar is expected to see import growth remain strong. The dollar is assumed to average around 69.0 on the TWI through to March 2008, higher than in the Half Year Update. Export volume growth is expected to decline to 0.4% on an annual average basis in March 2008, while import volume growth is expected to peak at 5.6% in the 2007 calendar year.

Businesses are positive about their own prospects …

Business investment growth increased in the second half of 2006. This likely reflected the renewed strength in domestic spending, the high exchange rate reducing the cost of imported investment goods, as well as difficulties in finding labour and increasing labour costs. Businesses remained positive about the outlook for their own activity in early 2007 and investment and employment intentions were positive. Business investment is estimated to have remained strong in the first quarter of 2007 and the annual average rate of growth is expected to reach 5.8% in March 2008.

… and growth in domestic demand is forecast to remain strong over most of 2007

Production GDP is estimated to have increased by 0.9% in the March 2007 quarter, taking annual average growth to 1.7%, off its low of 1.4% recorded in September 2006. Quarterly growth rates are expected to ease over the next two quarters, but annual average growth will reach 2.9% in September 2007. Growth in GNE is estimated to be stronger at 1.4% in the March quarter and forecast to be 1.0% in each of the next two quarters, taking annual average growth to 4.7% in 2007 as a whole.

Non-tradables inflation will remain high for some time

The resurgence in domestic demand in the last quarter of 2006 and the first quarter of 2007 led to higher inflation in non-tradable goods and services in the March 2007 quarter, with a quarterly increase of 1.2% and an annual increase of 4.1%. Consumer price inflation is expected to fall below 2.0% in June and September 2007 but to increase again to 2.6% in December 2007, with past changes in petrol prices responsible for the volatility. With the recent resurgence in domestic demand, inflation is expected to be higher throughout the forecast period than forecast in the Half Year Update.

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