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Economic Outlook

Growth is expected to slow over 2006 …

In the short-term some further momentum in domestic demand is expected. Solid GDP growth of 0.8% and 0.7% a quarter is forecast for the last two quarters of 2005. Growth of 2.9% is forecast in the year to March 2006. Below trend quarterly growth rates are forecast for 2006 through a combination of weak export growth and a slowing in domestic demand, as higher interest rates and an end to wealth gains from housing see a period of household consolidation.

… and the economy is forecast to record two years of sub-trend growth in March 2007 and 2008 …

During 2006 the combination of subdued export volumes and slowing domestic demand sees GDP growth slow to 1.7% in the year ended March 2007 and 2.5% in March 2008, compared with 2.6% and 3.5% respectively in the Pre-election Update. Growth is forecast to recover further to 3.8% in 2009 and to trend rates of growth of around 3% at the end of the forecast period. This outlook sees two years of sub-trend economic growth in 2007 and 2008 and would represent the weakest two consecutive years of growth since 1998 and 1999 following the Asian Crisis and drought.

Figure 1.7 – Real GDP
Figure 1.7 - Real GDP.
Sources: Statistics New Zealand, The Treasury

The outlook for growth is more cyclical than in recent forecasts. Part of the reason for this is the forecast adjustment in domestic demand. Some of the recent growth has been driven by household borrowing and growth is forecast to slow as past interest rate increases begin to affect behaviour. In a cyclical sense this is compounded by the outlook for exports, where volume growth is forecast to be limited due to a forecast weak recovery in dairy exports and the effect of the exchange rate on some other categories of exports. The combination of these domestic and external influences is forecast to lead to a bigger and more prolonged slowing in growth than forecast in recent Updates. The view of trend growth underlying these cyclical patterns is unchanged from the Pre-election Update.

… contributing to a slowing in tax revenue growth.

Tax revenue growth is forecast to decline. Weaker domestic demand growth leads to slower growth in GST and a decline in profits sees a slowing in company tax growth. There are risks around the tax forecasts. If economic growth does not slow to the extent forecast in the Central Forecast then tax revenue is likely to be stronger; likewise, higher inflation would see more tax revenue. Should household spending or the labour market slow more quickly, or further, than forecast, this would be associated with a period of weaker tax revenue. The risks and scenarios chapter considers the fiscal implications of two scenarios where judgements around the economy evolve differently from forecast in the Central Forecast.

Some key drivers of activity have turned down in recent times, while others are forecast to turn down over the next 12 months.

The prices of many of New Zealand’s commodity exports have begun to ease from previous highs. This is forecast to feed into a decline in the terms of trade during the early stages of the forecast period. Net migration inflows have eased over the past two years, interest rates have increased and the exchange rate remains at a high level. All of these factors are forecast to contribute to a further slowing in the rate of growth in GDP. To date these factors have largely been offset by a strong labour market and wealth gains from house price increases.

Figure 1.8 – SNA terms of trade
Figure 1.8 - SNA terms of trade.
Sources: Statistics New Zealand, The Treasury

The effect of interest rate increases on households is a key judgement underlying the forecasts …

In the short-term, recent labour income growth and house price increases are forecast to continue to provide momentum to private consumption growth. We expect that house prices will have recorded further increases over the second half of 2005, and have forecast some declines during 2006 as recent interest rate increases begin to slow activity. Strength in the housing market, together with solid labour income growth, sees quarterly GDP growth of 0.8% in September and 0.7% in December. Annual private consumption growth is forecast to be 4.4% in the March 2006 year, before declining to 1.8% in 2007 and 1.0% in 2008.

… as it leads to a slowing in private consumption growth, falls in residential investment and house prices.

A number of the factors that have supported growth in recent times have already reversed or are forecast to do so. The factors contributing to the slowing of consumption growth include:

  • The lagged effect of past interest rate rises on the effective mortgage rate faced by households.
Figure 1.9 – Private consumption and residential investment
Figure 1.9 - Private consumption and residential investment.
Sources: Statistics New Zealand, The Treasury
  • Higher oil and petrol prices which reduce the effective disposable incomes of households.
  • Lower additions to the population from net migration.
  • A slowing in house price growth and hence a reduction in wealth effects.
  • A slowing labour market including slowing employment growth, slower labour income growth and rising unemployment.

While interest rate increases appear to have had little effect on household spending over the last 12 months, over the forecast period growth is forecast to slow due to the lagged effect of past rate increases. Many households have been insulated from interest rate increases by fixed rate mortgages. As these roll over, borrowers will experience increases in the effective interest rates that they face, raising debt servicing costs. Households are forecast to react to this by reducing growth in private consumption and residential investment spending. Despite this slowing, debt servicing remains at a high level and the financial position of households is an important risk to the Central Forecast. The risks and scenarios chapter includes a scenario where households make a larger adjustment to spending. A larger correction in household spending would be likely to be associated with a larger slowdown in economic growth.

The slowdown in real consumption spending also sees nominal consumption growth slow, contributing to an easing in the growth of GST tax revenue. Higher interest rates than forecast in the Pre‑election Update are forecast to boost Resident Withholding Tax (RWT) over the forecast period. Higher rates have already begun to have an effect with recent RWT revenue exceeding forecasts as attractive interest rates have lifted the deposit base.

Figure 1.10 – Household debt servicing as a percentage of disposable income
Figure 1.10 - Household debt servicing as a percentage of disposable income.
Sources: Statistics New Zealand, The Treasury

Residential investment growth has already started to ease and this is forecast to continue with some of the fundamental drivers of activity, including the size of the population and interest rates increases, leading to declines in new building work. The box “Imbalances in the economy” discussed the increase in housing vacancy rates. With these already sitting at high levels, further expansion in investment in new dwellings is unlikely.

Some domestic demand growth is expected to be maintained by growth in real public consumption, which is forecast to growth at annual rates of around 6% until March 2007.

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