Domestic Outlook (continued)

Goods terms of trade remain solid...

Meanwhile, the relative price of our goods exports to that of our goods imports - the goods terms of trade - are also forecast to remain at historically high levels throughout the forecast horizon.

The goods terms of trade have eased back from close to a 40-year high over the past year or so, on the back of increased global dairy supply and an easing in global commodity demand reflecting weak trading partner growth conditions. We forecast the goods terms of trade to weaken further in the short term.

However, the recovery in global dairy prices over the past six months is expected to be reflected in an increase in the goods terms of trade in the first quarter of 2013. The observed pick-up in dairy prices has in part reflected concerns over the impact of US drought conditions on dairy supply - a factor that should also help to support the price of our meat exports in the longer term. The goods terms of trade are expected to surpass their June 2011 quarter peak by late-2013.

...supported by structural factors...

Moreover, with global demand for our commodity exports expected to strengthen over time, the prices of our commodity exports are expected to be supported at or near historical highs.

Indeed, with Chinese per capita consumption of dairy products forecast to increase as Chinese incomes rise, global demand for dairy products is likely to strengthen over time. Global supply will respond, although there are biological constraints to the speed at which it can do so. Moreover, global production costs are expected to rise in reflection of tighter environmental standards and increased land-use competition from bio-fuel and other food industries. All told, this combination of factors is likely to continue to put upward pressure on global dairy prices in the coming years. The ongoing scarring impact of the US drought on global meat supply should support prices until the later years of the forecast period.

Part of the expected increase in our export prices is likely to be offset by higher goods import prices. However, crucially, goods import prices are expected to rise at a slower pace than exports over the forecast period. Indeed, rises in the prices of consumer and intermediate goods imports are expected to be outweighed partly by falls in the price of capital goods - in keeping with their long-run decline - and, to a lesser extent, mineral fuels too. West Texas Intermediate (WTI) oil market futures contracts, which form the basis for our oil price assumption, are pricing in a gradual decline in oil prices over the forecast period. WTI oil prices are assumed to fall to around $86 per barrel in the first quarter of 2017 - some 7% lower than their average in the September 2012 quarter.

...helping to offset weakness in the services terms of trade

By contrast to the reasonably bright outlook for the goods terms of trade, the expected decline in the NZD increases the relative price of travel and other services imports for New Zealanders, and drives the expected weakening in the services terms of trade. Overall, the combined goods and services terms of trade remain at an historically high level throughout the forecast period, but deteriorate gradually from 2013 onwards.

Wider current account deficit...

Figure 1.16 - Goods and services terms of trade (System of National Accounts [SNA] basis)

Sources:  Statistics New Zealand, the Treasury

The current account deficit is expected to widen to 6.5% of GDP in the year ending March 2017, from 4.9% in the year ending June 2012. This deterioration in part reflects a widening deficit on services, from 0.4% of GDP in the March 2013 year to 1.9% of GDP in the March 2017 year - in line with the declining services terms of trade.

The surplus on the goods balance, currently 0.9% of GDP, falls into a small deficit in the March 2015 year before recovering towards the end of the forecast period as the lower exchange rate helps to boost export earnings. The income deficit narrows to around 4% of GDP in the March 2014 and 2015 years as lower global interest rates outweigh stable company profits. However, the income deficit widens to over 5% of GDP by the end of the forecast period as interest rates rise and profits of overseas-owned local companies pick up.

Figure 1.17 - Current account balance

Sources:  Statistics New Zealand, the Treasury

The transfers balance is forecast to remain in deficit throughout the forecast horizon reflecting the impact of higher insurance premiums in the wake of the Canterbury earthquakes.

...although national saving rises over the forecast period

From a saving and investment perspective, the forecast widening in the current account deficit reflects the expected increase in investment driven by the Canterbury rebuild and part-financed by overseas reinsurance flows. Statistics New Zealand estimates a total of $17.9 billion of reinsurance claims from all Canterbury earthquakes. At the end of the June 2012 quarter, $5.1 billion of these claims had been settled with overseas reinsurers, with these inflows recorded in the capital account of the balance of payments.

National saving is forecast to rise, mainly as a result of higher government saving. Household saving is expected to consolidate around current levels.

Figure 1.18 - Saving and investment

Sources:  Statistics New Zealand, the Treasury

Excluding earthquake-related investment, the current account in the Half Year Update forecasts would average around 4% of GDP over the forecast horizon, albeit widening slightly toward the end of the period.[2]

The net international liability position is forecast to rise from 72.6% of GDP at the end of June 2012 to 83.6% of GDP at the end of March 2017, reflecting a fall in international assets as insurance claims are settled.

Inflation is restrained...

Figure 1.19 - CPI inflation

Sources:  Statistics New Zealand, the Treasury

Annual CPI inflation fell to 0.8% in the September 2012 quarter - its slowest rate since December 1999. The fall was largely caused by the ongoing influence of a strong NZD, falling global commodity prices, and subdued domestic demand reflected in heavy discounting in the retail sector. Inflation is forecast to rise as downward price pressure from the high exchange rate fades, excises on tobacco and transport increase, and spare capacity in the economy is reduced. The rise in building activity is also expected to result in an increase in price pressures in the construction sector.

...and monetary policy stimulus is withdrawn...

The forecasts assume that monetary policy does not tighten to offset the temporary effects of the higher excises on the CPI. With inflation forecast to be weaker in the near term than at the Budget Update, the withdrawal of monetary stimulus in the forecasts is more gradual than at Budget too. Short-term 90-day interest rates are expected to remain around 2.7% until the September 2013 quarter. However, strengthening demand in the economy and diminishing spare capacity are forecast to lead to a gradual pick-up in inflation pressures. Short-term interest rates increase gradually from late 2013. Annual CPI inflation is expected to settle around the mid-point of the Reserve Bank's 1-3% target range from late 2013.