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Budget 2015 Home Page Budget Economic and Fiscal Update 2015

Recent Developments and Near-term Outlook

The economic expansion has gathered pace...

The pace of economic expansion strengthened over the second half of 2014 owing to strong domestic demand and a surge in tourism expenditure. Rapid migration-led population growth, increases in labour income, low interest rates and increased construction activity are expected to continue to support domestic demand, and underpin the outlook for growth over 2015.

Although real production GDP grew as expected over the second half of 2014, revisions to previous quarters by Statistics New Zealand meant that growth in the year ended December was lower than expected at 3.3% - but still the fastest pace since late 2007 (Figure 1.1).

Figure 1.1 - Real GDP growth
Figure 1.1 - Real GDP growth.
Sources: Statistics New Zealand, the Treasury

…with several developments impacting the economy and its outlook

Several key developments have shaped the economic outlook and have reinforced the key themes of strong real activity and relatively weak price inflation presented in the Half Year Update. These developments include the sharp falls in international oil prices since late last year, higher than forecast net migrant inflows and the impacts of the summer drought.

Judgements around the future path of commodity prices, trading partner growth, the extent and duration of the current migration cycle and the amount of spare capacity and its relationship with inflation remain the key factors influencing the economic outlook.

International oil prices fell sharply…

Oil prices have fallen sharply since the Half Year Update was finalised in November. WTI prices have fallen from around US$80 per barrel in November 2014 to around $US50 per barrel in March 2015 (Figure 1.2). Brent and Dubai crude oil prices have followed a similar pattern. The price falls are primarily a result of increased supply from US shale oil production and the Organisation of Petroleum Exporting Countries' decision to maintain production levels despite falling prices. At the same time, international demand has eased, partly reflecting a slowdown in growth in China.

Figure 1.2 - WTI oil price
Figure 1.2 - WTI oil price.
Sources: Haver Analytics, the Treasury

Changes in oil prices directly affect consumer prices through lower fuel prices and indirectly through lower input costs for domestic firms. In addition, New Zealand's major trading partners are net oil importers so the positive impacts on domestic demand in those economies, all else equal, support demand for New Zealand's exports.

…contributing to weaker than forecast inflation…

Falling fuel prices provided the largest negative contribution to the 0.3% fall in quarterly inflation in the March 2015 quarter. Annual consumer price inflation eased to 0.1% from 0.8% in the December quarter (Figure 1.3) - considerably lower than the 1.3% forecast in the Half Year Update. Even excluding the impacts of lower fuel prices, inflation is low and inflation expectations are subdued. Although some slack remains in the labour market, capacity utilisation is generally quite high, indicating that, in aggregate, spare capacity has largely been absorbed. Capacity pressures take some time to influence inflation and inflation is expected to remain low this year.

Figure 1.3 - Consumer price inflation
Figure 1.3 - Consumer price inflation.
Source: Statistics New Zealand

…and providing a partial offset to lower export prices

The near-term outlook for the terms of trade has improved as lower import prices have provided a partial offset to lower export prices. Lower export prices result in a direct fall in national income and lower inflation. However, lower import prices, which result in a higher terms of trade, increase real national disposable income. The overall impact on nominal GDP depends on the extent to which households and businesses respond to the additional real income and how lower import prices affect domestic prices.

See the box “Commodity prices” (page 12) for details on how recent commodity price movements and the judgements around their future paths have impacted the outlook for the terms of trade and nominal GDP.

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