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Budget 2014 Home Page Budget Economic and Fiscal Update 2014

Economic Outlook

Overview

  • The pace of expansion in economic activity quickened and broadened over the second half of 2013. This trend is likely to have continued in 2014. Over the second half of 2013, agricultural production recovered from the drought earlier in the year and exports rose strongly; business confidence increased and investment in capital goods accelerated; and economy-wide employment rose sharply, supporting growth in household incomes.
  • Household and business incomes have been further boosted by high prices for New Zealand's export commodities, which have underpinned record high levels in the terms of trade. The rise in incomes has been reflected in faster growth in private consumption expenditure and in market investment. Low interest rates, the Canterbury rebuild and strengthening net migration inflows are also adding to domestic demand.
  • Growth in demand has reduced spare capacity in the economy and consumer price inflation has increased, particularly for non-tradable goods and services. Prices in the tradable sector have continued to fall, reflecting weak import prices and the ongoing appreciation of the exchange rate, and have helped keep overall inflation moderate. At the same time, the high exchange rate is reducing the price competitiveness of firms in the tradable sector, and restraints on high loan-to-value mortgage lending are reducing the impact of low interest rates on parts of the economy.
  • Growth in New Zealand's major trading partners is gaining momentum, supported by expansionary monetary policy. However, inflation is low in many countries, public and private debt is high and financial stability risks, while reduced, remain a threat to the recovery. Internationally, monetary policy accommodation is expected to remain in place for some time.
  • Domestically, the pace of expansion in the economy is expected to quicken to 4.0% over the next year and employment is forecast to increase by 3.0%. The relatively positive growth outlook and the accompanying inflationary pressures have led the Reserve Bank to begin returning interest rates to more neutral settings. Short-term interest rates are forecast to rise to 4.3% in the March 2015 quarter and to 4.8% a year later, and consumer price inflation is expected to peak at around 2.5% in mid-2016 and to ease to 2.0% in early 2018.
  • Expectations of widening interest rate differentials are providing support for the current high level of the New Zealand dollar. The trade-weighted exchange rate is assumed to remain elevated throughout the forecast period, which slows growth in the tradables sector and contributes to a widening of the current account deficit.
  • Beyond 2015, tighter monetary conditions, combined with a decline in the terms of trade and slowing net migration inflows, contribute to a period of more moderate growth that enables inflation to stabilise and the exchange rate to depreciate. Nonetheless, the exchange rate remains high at the end of the forecast period and continues to constrain export growth, while import demand continues to be supported by the Canterbury rebuild. This is reflected in a current account deficit of 6.3% of GDP in 2018.
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