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Half Year Economic and Fiscal Update 2013

Economic Outlook

Economy set for period of above-potential growth in the near term...

The near-term outlook for the New Zealand economy is robust, with an increasingly embedded and broad-based pick-up in activity anticipated following a drought-affected first half of 2013. The Canterbury rebuild is showing signs of gaining momentum, the labour market is strengthening and monetary conditions remain stimulatory. Strong external demand for New Zealand's commodity exports, particularly dairy, has underpinned a rebound in the terms of trade to near-record highs and domestic demand has received further support from a marked turnaround in net migration inflows since the start of the year.

Overall, real GDP growth is forecast to accelerate above its potential rate in the coming years, peaking at 3.6% in the March 2015 year. This will result in an increase in price pressures and will necessitate withdrawal of monetary policy stimulus in the first half of 2014. There is likely to be some variation in growth and activity at a regional level.

...followed by a moderation in the later years

Real GDP growth is expected to moderate to a more sustainable pace later in the forecast period, in line with the Treasury's estimate that potential growth will average around 2.4% over the forecast period. This reflects the Treasury's assessment of growth in the labour force and productivity in the longer run.[1]

The assumed depreciation in the New Zealand dollar is forecast to begin to stimulate activity in the exchange rate-sensitive parts of the economy, such as the services and non-commodity export sectors, towards the end of the forecast period.

Outlook reflects net impact of large influencing factors

The growth outlook for the New Zealand economy reflects the net influence of a number of large supportive and constraining forces.

Many of the supportive factors that are expected to influence domestic activity over the forecast period do so in a similar manner, and to a similar extent, as forecast at the Budget Update. These include the impetus from the Canterbury rebuild, stimulatory monetary policy settings and a strengthening labour market.

Overall, however, the net impact of the supportive influences on demand in the near term is slightly stronger than forecast at the Budget Update, including a larger-than-expected turnaround in net migration flows reflecting the recent weaker performance of the Australian economy. We judge the balance of risks to the central forecast to be balanced, but explore alternative economic scenarios in the Risks and Scenarioschapter.

Canterbury rebuild remains a key influence across the forecast period...

The Canterbury rebuild is expected to provide significant impetus to demand over the forecast horizon and beyond, chiefly through additional residential and business investment, supported by higher private consumption, particularly of consumer durables.

Estimating the level of investment activity associated with the Canterbury rebuild is inherently difficult and subject to much uncertainty. The Treasury's estimate of the total level of investment that relates to the Canterbury rebuild is similar to that in the Budget Update at around $40 billion. Approximately half of this total investment is forecast to have taken place by the end of the forecast period in mid-2018.

...underpinning strong growth in residential investment...

After a soft patch in the middle of the year, a surge in building consents in the Canterbury region in the September quarter suggests that residential rebuild activity is about to increase significantly. Annual real residential investment growth is forecast to accelerate to a peak of around 26% in the March 2015 year. This peak in growth occurs slightly later and at a lower level than forecast in the Budget Update, but the broad picture is similar in level terms. Over two-thirds of the residential rebuild is expected to be completed by the end of the forecast period in 2018.

While the Canterbury rebuild is expected to provide a large proportion of the impetus for the surge in residential investment over the forecast period, activity in other parts of the country is also expected to rise significantly, particularly in the Auckland region. The drivers of the underlying growth include a catch-up for past population growth, expected future population increases (including through migration), rising household income, and low, albeit rising, interest rates. Figure 1.2 shows the share of real residential investment with and without the Canterbury rebuild. Including rebuild-related activity, residential investment is forecast to peak at around 6% of real GDP - in line with the share reached in the early-2000s.

Figure 1.2 - Real residential investment[2]
Figure 1.2 - Real residential investment.
Source: Statistics New Zealand, the Treasury

Rapidly rising house prices, particularly in the Auckland region, are expected to encourage an increase in new home building, although this will take time. The implementation of LVR lending restrictions by the Reserve Bank makes it less certain how the supply and demand dynamics in the housing market will play out. Higher-than-expected net migration inflows mean that annual house price inflation is forecast to be stronger in the near term than in the Budget Update. However, the impact from migration is offset to some extent by the LVR lending restrictions, which are expected to impose a modest dampening effect on house price inflation in the near term. Annual house price inflation is forecast to peak at around 10% in the December 2013 quarter, before moderating to 2.4% towards the end of the forecast period.

The forecast track for short-term interest rates in the Half Year Update is broadly similar to that in the Budget Update, but is around 30 basis points lower in the first half of the forecast period than it would have been if LVR restrictions had not been implemented (consistent with the Reserve Bank's estimates).

Notes

  • [1]See the note, Potential Output in the 2012 Half Year Update, published as part of the 2012 Half Year Economic and Fiscal Update ,for background information (available on the Treasury website).
  • [2]Note that the “Excluding Canterbury rebuild” line is only illustrative and should not be interpreted as an alternative forecast of what would have occurred in the absence of the Canterbury earthquakes.
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