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Budget 2006 Home Page Half Year Economic & Fiscal Update 2006

Recent Economic Environment

Annual GDP growth has slowed over the past 18 months

GDP increased 0.8% in the March 2006 quarter and 0.5% in the June quarter, rebounding from two soft quarters in the second half of 2005 which saw the economy record close to zero growth. Looking across this period of volatility in quarterly growth reveals a picture of an economy where growth has slowed compared with the strong growth of the preceding few years. However, our assessment is that the economy is past the weakest period of growth, which occurred at the end of 2005, and is well into a period of modest growth, despite the build-up of a number of imbalances in the economy that cloud the future outlook.

Figure 1.2 – Growth in real GDP
Figure 1.2 – Growth in real GDP.
Source: Statistics New Zealand

Imbalances still exist in the economy, highlighted by a current account deficit of 9.7% of GDP …

A number of recent Budget and Half-Year Updates have highlighted imbalances in the economy. The long period of strong growth in the economy has seen the emergence of macroeconomic imbalances – a rise in inflation pressures and a large current account deficit. The corollary of these imbalances has been tighter monetary policy and a high exchange rate that has seen the export and import-competing sectors come under pressure.

… and headline inflation of over 3%

The CPI increased 1.5% in the June quarter, which took annual CPI inflation to 4.0%. A spike in oil prices to US$78/barrel during the conflict in Lebanon saw petrol prices and international airfares both make large contributions to the quarterly increase in the CPI. Cheaper prices for cars and a smaller than expected increase in international airfares both contributed to a 0.7% increase in the index in the September quarter. The quarterly increase was smaller than forecast in the Budget Update.

Annual inflation was 3.5% in September, higher than the 3.1% rate forecast in the Budget Update. While petrol price increases have contributed to some of this result, non-tradables inflation has also proved to be higher than forecast, with the demand pressures in the economy continuing to push prices up. Annual non-tradables inflation was running at 4% in the September quarter and has now been at or above 4% since December 2003. Some of the largest contributions to non-tradables inflation have come from the housing and household utilities group.

Pressure on resources and the persistence of non-tradables inflation have contributed to the Reserve Bank keeping the Official Cash Rate steady at 7.25%. With this still representing a sizeable wedge between New Zealand and offshore interest rates, New Zealand has remained an attractive destination for international investors, contributing towards a lift in the Trade-Weighted Index (TWI) measure of the New Zealand dollar to around 66, up from 60 in July 2006.

Recent GDP growth has exceeded the forecasts underlying the Budget Update …

At the time of the Budget Update,GDP growth was forecast to slow to 1% in the year to March 2007, with quarterly growth of 0.2% to 0.4% forecast across the 2006 calendar year. This outlook was built around a slowing in domestic demand, while exports were forecast to be weak due to the effects of a poor agricultural season combined with a high exchange rate. Growth was subsequently forecast to rebound in the year to March 2008, owing to the effects on exports of an expected decline in the exchange rate. While services exports have been stronger than forecast, most of the difference on the export side has been in agricultural exports, owing to a surge in dairy exports from inventories, with dairy exports increasing much more than production.

… despite tentative signs of a rebalancing in growth as domestic demand has slowed …

Domestic demand growth has slowed over recent months. The large contributions to growth from the household sector in the form of private consumption and residential investment have eased. This reflects the impact of interest rate increases during 2005 on households and an easing in net migration from its peak of over 40,000 per annum in 2003. In addition, declines in the terms of trade at the end of 2005 and the beginning of 2006 have effectively reduced household disposable income through rising import prices, especially petrol, and some falls in international prices of some New Zealand exports.

Figure 1.3 – Contributions to real GDP growth
Figure 1.3 – Contributions to real GDP growth.
Source: Statistics New Zealand

The corporate sector has also experienced a slowdown, with firms trimming investment. Firms’ margins have been under pressure during the past 12 months, with firms unable to fully pass on to customers rising cost pressures, especially for labour and petrol. Firms have responded by cutting back investment, with the depreciation of the exchange rate early in 2006 raising the cost of imported investment goods and discouraging new investment.

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