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Budget 2006 Home Page Half Year Economic & Fiscal Update 2006

Economic Outlook

Modest quarterly GDP growth of 0.4 to 0.6% is forecast through the end of 2006 and much of 2007

Quarterly GDP growth is forecast to cluster around 0.5% per quarter from the December 2006 quarter through the first half of 2007. Annual average growth of 1.8% is forecast for March 2007, with 2.3% growth forecast in the year to March 2008. After growth of 2.2% in 2006, this outlook means that growth would have been below the trend, or potential rate of growth, which we assess as around 3%, for three consecutive years. This growth outlook is forecast to flow into softer labour market conditions and lower growth in tax revenue.

Figure 1.6 – Growth in real GDP
Figure 1.6 – Growth in real GDP.
Sources: Statistics New Zealand, The Treasury

The weak period of growth is underpinned by some consolidation in the household sector, with households judged to be less willing to take on debt in the face of debt servicing ratios reaching record high levels, as well as a weak period of export volume growth owing to the lift in the exchange rate during the middle of 2006. This appreciation of the exchange rate is forecast to push out a recovery in exchange rate-sensitive categories of exports into the 2008 calendar year, based on an assumption of some falls in the exchange rate during 2007.

Imbalances are likely to continue to exist for some time …

The imbalances in the economy are forecast to remain for some time. The central forecast at the time of the Budget Update suggested that the imbalances would start to reverse early in 2007, with exports forecast to rebound quickly on the back of a depreciation of the exchange rate. Since the Budget Update was finalised, the exchange rate has increased back to 66 on a TWI basis. This lift in the exchange rate in the middle of 2006 is now forecast to delay the recovery in exports until the 2008 calendar year. As a result, the reorientation of growth in the economy will be relatively slow.

… with inflation expected to be close to 3% by the end of 2007 and the current account deficit close to 9% of GDP…

A period of forecast volatility in headline inflation, largely owing to the effects of petrol prices, somewhat clouds inflation pressure in the economy. Strong growth in domestic demand, accompanied by pressure on resources, has pushed non-tradables inflation to over 4% since late 2003. These pressures on resources, particularly in the construction sector, are forecast to continue during much of 2007 and non-tradables inflation is not forecast to fall below 4% until December 2007. Headline inflation is forecast to fall initially before rising back to 2.8% in December 2007.

With reorientation of growth in the economy forecast to occur in an orderly, but relatively slow way, the current account deficit is forecast to remain close to 9% of nominal GDP through 2007. Import volume growth is forecast to be weak, increasing 0.9% in the March 2008 year owing to weak domestic demand. Growth in export volumes, however, is also forecast to be muted, increasing 1.4% in the March 2008 year. As a result, while the current account deficit is forecast to become smaller during 2007, it is expected to remain close to 9% of GDP.

… however, two more years of sub-trend growth in the March 2007 and 2008 years is forecast to lead to an alleviation of inflationary pressures …

With domestic demand growth forecast to be weak owing to consolidation in the household sector, as well as further weakness in market investment, inflationary pressures in the economy are forecast to ease. This is expected to result in inflation moving back inside the Reserve Bank’s target range. By 2008, inflation pressures are forecast to decline. Non-tradables inflation is forecast to fall below 3% by September 2008 and headline CPI inflation is forecast to be 2.2% by December 2008.

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