Domestic Outlook (continued)

Consumption a solid driver of growth...

Total consumption also makes a solid contribution to GDP growth across the forecast period. Annual household consumption growth is expected to increase from 1.5% over the year ending March 2013 to 2.8% in the year ending March 2014. Growth is underpinned by robust demand for durable goods, such as furniture and furnishings, associated with the expected rise in residential investment and newly constructed dwellings.

Figure 1.10 - Real private consumption growth

Sources:  Statistics New Zealand, the Treasury

...notwithstanding offsetting factors...

As with overall GDP growth, a combination of factors is expected to impinge on household spending decisions over the forecast period.

First, following the build-up of household debt over the 2000s, households are likely to be less willing to take on additional consumer debt going forward than in the past. This change in behaviour is a necessary foundation for more sustainable growth in the medium and long term. However, it will require slower growth in consumer spending than was seen during the past decade.

The second factor that is expected to impinge on household spending decisions over the coming years is the subdued outlook for house price inflation, and weaker wealth effects in general. Following a 6.5% rise in the March 2013 year, driven in large part by the buoyant Auckland market, a pick-up in national supply and higher interest rates mean that house prices are forecast to increase by less than the pace of consumer price inflation over the forecast period.

...and loose labour market conditions...

Figure 1.11 - Labour market

Sources:  Statistics New Zealand, the Treasury

The final factor that is likely to constrain the pace of growth in household spending over the forecast period is ongoing loose labour market conditions. Despite recent weak outturns, we continue to expect employment growth to pick up over the forecast horizon as the Canterbury rebuild and improvement in business confidence increase demand for labour. Employment growth rises to 1.9% in the March 2015 year - its fastest annual pace since the March 2007 year - and the unemployment rate is expected to decline to just below 5% in the June 2017 quarter.

Constraints on the Canterbury rebuild are likely to see construction sector wages rise more rapidly than those in other industries over the coming years. There is a risk that this exerts more upward pressure on wages in other industries than is factored into our forecasts, especially if rebuild activity exacerbates skills mismatches in the labour market.

Figure 1.12 - Average ordinary-time hourly earnings

Sources:  Statistics New Zealand, the Treasury

Meanwhile, changes to the Government's welfare policies, which have strengthened job search incentives, have also been incorporated into our forecasts in the form of a slight increase in the labour force participation rate.

However, the surprise jump in the unemployment rate in the September 2012 quarter means that the starting point for the labour market forecasts in the Half Year Update is higher than at the time of the BudgetUpdate. Accordingly, the unemployment rate in the Half Year Update forecasts is higher across the forecast period than in the Budget Update, and the looser labour market conditions are reflected in weaker wage growth forecasts too. Annual wage growth eased to 2.8% in the September 2012 quarter, down from a peak of 3.8% in the March 2012 quarter, and is expected to average 2.5% over the forecast period.

Figure 1.13 - Real government consumption

Sources:  Statistics New Zealand, the Treasury

On balance, we expect private consumption largely to grow in line with income growth over the forecast period. Given the forecast pick-up in residential investment, though, the overall borrowing requirement of households is likely to increase.

...as well as tighter fiscal policy

The Government's commitment to spending restraint in Budget 2012 and in earlier Budgets is reflected in low growth in real government consumption throughout the forecast horizon. With this forecast pace of growth lagging behind that of overall GDP, government spending on goods and services' share of real GDP falls from 18.5% at present to 16.7% in the June 2017 quarter. Combining this with the other components of government spending (transfer payments and capital spending) and the revenue it is receiving (mainly taxes), means the Government is forecast to be subtracting from domestic demand growth over much of the forecast period.[1]

External sector initially a drag on growth...

Figure 1.14 - Export volume growth

Sources:  Statistics New Zealand, the Treasury

Turning to the external sector, a continuation of favourable weather conditions for our main commodity exports should support goods export growth in the March 2013 year. This is driven in the main by dairy exports, which appear to have been boosted by a run-down in inventories in the September 2012 quarter.

However, the overall pace of growth of goods exports is forecast to slow in the March 2014 year as agricultural conditions are assumed to ease back to normal. Given the discouraging effect of the strong exchange rate and weak economic conditions in our traditional tourist source markets, services exports are expected to remain subdued too. Total export growth is expected to slow to 0.5% in the March 2014 year - its slowest pace since the March 2009 year.

With this soft patch in export growth forecast to coincide with a pick-up in imports, net exports detract from real GDP growth in both the March 2014 and 2015 years. Growth in imports accelerates from 2.0% in the March 2013 year to 6.6% in the March 2014 year.

...but improves in the later forecast years

Figure 1.15 - Export and import volume growth

Sources:  Statistics New Zealand, the Treasury

Thereafter, net export volumes begin to make a positive contribution to real growth, driven in part by a slowdown in the pace of the Canterbury rebuild and related imports as well as the assumed decline in the exchange rate. Import volumes growth in our Half Year Update forecasts slows to 1.6% and 0.3% in the March 2016 and 2017 years respectively. The turnaround in net exports also reflects a pick-up from the export side. Services exports will benefit from the expected gradual improvement in the global economy, and the forecast of a lower exchange rate will boost tourism exports as well. On the commodity export side, ongoing conversions of sheep and beef farms to dairying, as well as further productivity gains and investment, are expected to underpin dairy export growth of around 3% per year in the medium term. Meat and other commodity exports, including horticulture, wine, seafood, and minerals, are likely to benefit from deeper links with Asian export markets too.

Annual growth in export volumes surpasses that of imports from the March 2016 year onwards.