Domestic Outlook (continued)

...but national saving also rises

Figure 1.18 - Saving and investment

Sources: Statistics New Zealand, the Treasury

From a saving and investment perspective, the widening of the current account reflects the expected increase in investment driven by the Canterbury rebuild and part-financed from overseas reinsurance inflows. The inflows are recorded in the capital account of the balance of payments. Statistics New Zealand estimates over $15 billion of reinsurance inflows for the earthquakes have been paid to New Zealand insurers to date, reflecting the high level of insurance coverage by Canterbury businesses and households. The large proportion of home and business equity protected by insurance policies means that households and businesses can continue saving, contributing to a rise in national saving. The Government's programme of fiscal consolidation further supports national saving.

The net international liability position is forecast to rise from 72% of GDP at the end of 2011 to 81% of GDP at the end of March 2016, driven by a fall in international assets as insurance claims are settled. At the end of the forecast period, a small proportion of the insurance claims remain to be settled and the current account deficit remains above its sustainable level, suggesting that the net liability position will deteriorate further. The Treasury estimates that a current account deficit of 4% of GDP would stabilise net international liabilities at 85% of GDP.

Firmer labour market...

Figure 1.19 - Labour market

Sources: Statistics New Zealand, the Treasury

The labour market has firmed over the past year and this is expected to continue over the forecast period. In the year ending December 2011, the number of people employed increased 1.6% and the unemployment rate eased to 6.4% (revised up from 6.3%). Data released after the forecasts were finalised show employment increased 1.4% in the year ending March 2012, compared to a forecast rise of 1.3%, and the unemployment rate increased to 6.7% in the March 2012 quarter, higher than the 6.3% forecast. A higher labour force participation rate, which rose to 68.8% compared to a forecast of 68.3%, accounts for most of the difference between the actual unemployment rate and the forecast rate. The participation rate can be volatile but, if sustained, the increase in the size of the labour force points to greater spare capacity in the labour market, which may moderate inflation pressures as a result of weaker wage growth and the assumed rise in labour productivity.

Employment growth is expected to remain modest over 2012, but to begin rising more quickly in 2013 as the Canterbury rebuild increases labour demand. Employment growth of 1.6% is expected in the years ending March 2014 and 2015, up from 1.3% in the year ending March 2013, easing to 1.4% in the final year of the forecasts.

Labour force participation has averaged a little over 68% of the working-age population in recent years. Participation in older age groups has been increasing, but that has been offset by falling participation in younger age groups, where unemployment is highest. These trends are expected to continue, and the participation rate is forecast to remain close to 68% over the forecast period.[3] The unemployment rate is expected to decline to 4.7% in the March 2016 quarter, reflecting ongoing employment growth.

...leads to ongoing wage growth

Annual wage and salary growth accelerated to 3.8% in the March 2012 quarter, up from 2.6% in the previous March quarter. The wage and salary data for the March quarter was released after the forecasts were finalised, and shows that wages and salaries grew more strongly than expected. If sustained, the most recent data point to higher wage growth than contained in our forecasts. However, when considered alongside the moderating influence of the higher unemployment rate on wage growth, the forecast for wages to continue growing at around the current rate remains appropriate.

The Canterbury rebuild will likely see construction sector wages rise more rapidly than those in other industries. There is a risk that this exerts more upward pressure on wages in other industries than is currently factored in, either because of greater labour shortages for the types of labour skills required or because labour productivity in the rebuild is lower than expected. On the other hand, the localised and intensive nature of the rebuild may lift labour productivity.

Inflation is restrained...

Inflation is restrained but is forecast to rise as downward price pressure from the recent appreciation of the exchange rate fades, excises on tobacco and transport increase, and spare capacity in the economy is reduced.

Figure 1.20 - CPI inflation

Sources: Statistics New Zealand, the Treasury

The Treasury estimates the output gap, a measure of spare capacity, to be around 1% of GDP currently. This is contributing to relatively low domestically generated, or non-tradable, inflation. The acceleration in business investment over the next two years increases productive capacity, partly through an increase in imports, but output increases more rapidly and the output gap narrows, closing at the end of the forecast period. With resources less than fully employed across the forecast period, non-tradables inflation is expected to remain restrained. However, in the year ahead, rising insurance premiums, higher excises on tobacco and transport, and higher rental accommodation prices, are expected to increase non-tradable inflation. With tradable inflation also increasing, headline inflation is forecast to rise to 2.6% in the March quarter of 2013. Further tobacco excise increases, ongoing but diminishing spare capacity, and a depreciating exchange rate, contribute to inflation remaining around 2.4% over the remainder of the forecast period.

...and monetary policy stimulus is withdrawn...

The forecasts assume that monetary policy does not tighten to offset the temporary effects of the higher excises on the CPI. However, strengthening demand in the economy and diminishing spare capacity are forecast to lead to a gradual withdrawal of monetary stimulus. The withdrawal of this support is forecast to begin in early 2013. Short-term 90-day interest rates are expected to rise from 2.7% in the March 2012 quarter to 4.4% in the March 2016 quarter.