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Budget 2016 Home Page Budget Economic and Fiscal Update 2016

Recent Developments

Economic growth picked up on the back of solid domestic demand…

The pace of economic expansion accelerated in the second half of 2015. Real GDP grew 0.9% in both the September and December quarters, faster than the Half Year Update forecasts of 0.6% (Figure 1.1), on the back of strong growth in the service industries, reflecting high net migration and tourist inflows. Residential construction growth picked up from earlier in the year, as housing supply in Auckland responded to high demand. However, weaker global dairy prices started to flow through to lower dairy export receipts, although elevated tourism spending provided a positive offset for export growth. Per capita real production GDP growth fell to 0.6% in the calendar year 2015 from 2.2% in 2014, as aggregate growth was driven largely by population growth.

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

…as population growth increased…

Net inward migration reached a record of 68,000 in the year to March 2016, exceeding its Half Year Update forecast peak of 62,700. Increased arrivals drove net migration gains, and are likely to give a larger near-term boost to demand than supply compared with lower departures as the main driver. Working-age migrants require accommodation and other necessities following arrival, but may take some time to enter the labour market. Private consumption expanded 1.6% in the second half of 2015, up from 0.9% in the first half, reflecting strong population growth and low interest rates.

…strong housing demand persisted…

Strong housing demand continued to support residential investment. While house sales fell in the December quarter 2015 as the market adjusted to regulatory changes (Figure 1.2), the impact of these changes on demand softened in early 2016 as the fundamentals underpinning strong demand - population growth and low mortgage rates - reasserted themselves, leading to a rebound in house sales (see the box on page 13 for details on construction and other recent developments in the housing market). Residential investment expanded 5.0% in 2015, exceeding the pace of GDP growth, and was driven increasingly by Auckland, where annual growth in the median house price reached 25% in the middle of 2015 before slowing in the December quarter.

Figure 1.2 - House sales and mortgage rates
Figure 1.2 - House sales and mortgage rates.
Source: Real Estate Institute of New Zealand, Reserve Bank

…and interest rates fell

Further monetary easing added support to domestic demand. The Reserve Bank reduced the Official Cash Rate (OCR) by 125 basis points (bps) between June 2015 and March 2016, leading to a large fall in short-term interest rates, although the fall in floating mortgage interest rates was less pronounced owing to increased overseas funding costs. The Reserve Bank stated that its recent rate reduction in March was in response to a weaker global outlook and recent falls in inflation expectations, which are likely to negatively affect wage- and price-setting behaviour throughout the economy.

However, subdued demand from New Zealand's key trading partners…

Trading partner growth eased in 2015, chiefly as growth slowed in China and other emerging economies, while growth in developed economies remained moderate. China's growth slowed as the economy transitions from an investment-led model to greater emphasis on consumption as a driver of growth, and as authorities balance reform and short-term stimulus. Slower growth in China had flow-on effects to other Asian trading partners, and concerns over its growth outlook contributed to high financial market volatility in early 2016, which was characterised by increased demand for safe-haven assets and volatile equity markets.

The slowdown in China affected Australia through a further fall in its terms of trade. However, the Australian economy is shifting from mining investment towards other investment, consumption and exports as drivers of growth, supported by low interest rates and currency depreciation. The recovery in the US and UK slowed as low oil prices reduced investment in oil exploration and strength in their exchange rates constrained their manufacturing sectors, although both currencies fell recently. Growth remained subdued in Japan and the euro area as these economies continue to experience weak demand.

Commodity prices fell owing to weaker global demand and increased supply. Crude oil prices declined around 30% in the March 2016 quarter from a year ago to US$33/barrel, their lowest level since 2008, after a fall of around 50% in the year to March 2015. Reflecting slow global growth and falls in commodity prices, global inflation remains weak and monetary policy remains highly accommodative across developed economies.

…continued to weigh on dairy prices...

Global dairy prices fell by more than 50% over 2014 and 2015 as they came under pressure from increased supply and weak demand (Figure 1.3). Dairy prices rose briefly in late 2015 on expectations that El Niño might curb New Zealand milk production, but these price gains were reversed in early 2016 as it became apparent that the impact of El Niño was not as great as expected and global supply growth remained strong. Fonterra lowered its farmgate milk price forecast for the 2015/16 season to $3.90/kg of milk solids, lower than the price of $4.40/kg in the 2014/15 season.

Figure 1.3 - Dairy prices
Figure 1.3 - Dairy prices.
Source: GlobalDairyTrade, the Treasury

The goods terms of trade fell 4.9% in the December quarter 2015 from December 2014, to be down 13.6% from their peak in December 2013, as lower export prices, led by dairy, more than offset the drop in import prices, driven by crude oil.

The El Niño weather pattern has had a smaller impact on agricultural conditions to date than projected in the Half Year Update, but the anticipation of it influenced farm production decisions. Meat export volumes grew strongly over the second half of 2015 as farmers sent livestock to slaughter in anticipation of dry conditions. Meanwhile, lower dairy prices were likely the main factor behind the fall in dairy production in the 2015/16 season. Falls in export prices and a drop in dairy production reduced export receipts, contributing to a widening in the annual goods trade deficit in the December quarter. Despite a wider goods deficit, the annual current account deficit narrowed to 3.1% of GDP in the December quarter from 3.3% in the September quarter, driven by a rise in the services surplus and a fall in income earned by foreign investors in New Zealand.

...but the impact on the current account was offset by tourist spending

Elevated tourist arrivals supported services exports. Overseas visitor arrivals rose 9.6% in 2015, driven by an increase in Chinese and Australian visitors, as travellers perceive higher personal risks in some other parts of the world, China incrementally loosened travel restrictions and depreciation in the New Zealand dollar reduced the cost of visiting New Zealand. Reflecting high tourist arrivals, travel services exports (chiefly tourism) rose 26% in the year, leading to a 17% increase in the value of services exports.

Strong growth in labour supply leads to higher spare economic capacity…

While labour demand in the economy was solid, it was matched by increases in labour supply, owing to elevated net migration inflows. The working-age population grew 2.3% in 2015, up from 2.1% in 2014, with three-quarters of the growth in 2015 driven by net migration inflows, lifting the economy's productive capacity. Consequently, spare capacity in the economy is estimated to have remained significant in the second half of 2015, despite solid domestic demand.

…weighing on inflation and nominal GDP growth

Annual inflation remained low at 0.4% in the March quarter 2016.[1] Annual tradables inflation remained weak at -1.2% owing to falling petrol prices. Non-tradables inflation was low at 1.6%, reflecting significant spare capacity in the economy. Low inflation and falls in the terms of trade led nominal GDP growth to slow to 3.3% in 2015 from 5.1% in 2014.

However, stronger-than-expected real (or volume) GDP growth led nominal growth to exceed its Half Year Update forecasts. Consistent with stronger-than-expected nominal GDP growth, tax revenue in 2015/16 has so far exceeded forecast, driven by source deductions and goods and services tax (GST), which reflect faster growth in total labour income and consumption than expected. See the Fiscal Outlook chapter for recent developments in tax revenue.

Notes

  • [1]The March quarter CPI was released after the finalisation of the economic forecasts. See the box on page 14 for details on data developments after forecast finalisation and their implications for the economic outlook.
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