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

Growth Forecast to Slow and Imbalances Expected to Subside During 2008 and 2009

The impetus to growth from a number of current drivers is expected to weaken

The aggregate effects of the above forces that are currently boosting growth are expected to wane as 2007 progresses. From late 2007 and through most of 2008, we expect the influence of the high exchange rate and higher interest rates to become the more dominant driver of the economy.

The central forecast assumes that the TWI will average around 69.0 through to March 2008, with most of the factors currently supporting the NZ dollar expected to remain in place. This level is below 71.7, the rate prevailing at the time the forecasts were finalised.

Export revenue growth is likely to continue to be restricted by the high level of the exchange rate and a forecast decline in the terms of trade …

Figure 1.11 - SNA total terms of trade
Sources: Statistics New Zealand, The Treasury

Export revenues are forecast to be flat through most of 2008. This reflects the impact of the level of the exchange rate, as well as a forecast decline in the terms of trade during the 2008 calendar year. We expect that the factors currently pushing the world prices of some exports, particularly dairy, to record high levels will not be sustained throughout the forecast period. Supply conditions in other parts of the world are expected to return closer to normal levels, while demand is expected to ease somewhat, given the current high prices.

The assumed depreciation of the exchange rate during 2008 is consistent with the forecast decline in the terms of trade and a narrowing of interest rate differentials.

… while volumes, particularly of services exports, are forecast to remain under pressure during 2008 …

Our estimates suggest that exchange rate sensitive components of export volumes, particularly services, forestry and manufacturing, are affected by the exchange rate with a lag of around three to four quarters. The high level of the exchange rate has limited export volume growth in recent times, and with the depreciation in the exchange rate in the central forecast not expected to occur until the middle of 2008, a sizeable increase in export volumes is not expected until the latter part of 2008 and then more strongly in 2009.

Figure 1.12 - Export volumes
Sources: Statistics New Zealand, The Treasury

How long the exchange rate remains at elevated levels is a key judgement in the central forecast

New Zealand’s historical experience shows that the exchange rate can move through large cycles. If the level of the exchange rate reached during April 2007 is maintained for only a short period of time, followed by a depreciation, the effect on export volumes will not be as large as in the central forecast. The Risks and Scenarios chapter highlights a scenario where the exchange rate depreciates quickly.

Increases in effective interest rates during 2007 are expected to lead to an easing in domestic demand …

Most home loans in New Zealand are for fixed durations, albeit of a relatively short nature. As a result it takes time for increases in the Official Cash Rate (OCR) to flow into the actual interest costs faced by households, and therefore some time to affect their behaviour. Although people have moved onto longer-term loans, they will eventually feel the effect of past rate rises.

Figure 1.13 – Final domestic demand – percentage point contribution to growth
Sources: Statistics New Zealand, The Treasury

In such an environment we expect households to be more cautious about increasing their expenditure through the accumulation of debt than in the recent past and this is forecast to reduce private consumption growth. The level of household debt is forecast to increase, but the rate of increase is forecast to be slower than in the recent past. Households are also likely to be more reluctant to undertake substantial new investments in housing. Residential investment is forecast to fall by around 5% in the year to March 2009.

Further discussion of some of the factors affecting household decisions is provided in the box titled “Drivers of Private Consumption”.

… and an end to house price increases

Higher interest rates, as well as declining GDP growth rates, are forecast to lead to an easing in demand for houses. A small fall in house prices is forecast between March 2008 and March 2009. The end of large house price increases will see households’ net wealth position retrace some of the increases made over recent years, removing one of the key drivers of the recent strength in private spending.

Fiscal policy is expected to make a smaller contribution to domestic demand

Additions to government spending are forecast to be smaller during the 2009 March year than in the preceding years, with the additional impetus from Working for Families easing and slower growth in public consumption and non-market investment. The impact of government assistance through the Working for Families package is touched on in the “Drivers of Private Consumption” box.

While the contribution to domestic demand from government spending is expected to be smaller during the 2009 March year onwards, compared with the two to three preceding years, the combined influence of public consumption and non-market investment is forecast to provide a relatively steady contribution of just under ¾ percentage points to annual average growth.

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