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Half Year Economic and Fiscal Update 2014

Recent Developments and Near-term Outlook

Economic activity has continued to expand at a solid pace...

The pace of economic expansion has continued to strengthen owing to strong domestic demand. Rapid population growth, increases in income, and strong investment growth are expected to continue, supporting the domestic impulse underpinning growth in the near term.

The June quarter GDP outturn was in line with the Pre-election Update and the outlook remains broadly unchanged in real terms. Real production GDP increased 0.7% in the June quarter, easing from an above-1% pace in the three preceding quarters. In the year ended June 2014, GDP grew 3.5%, owing to broad-based strength across most industries (Figure 1.1). Amongst the expenditure components, real private consumption rebounded from a flat quarter in March, up 1.2%, led by higher expenditure on services and durables.

Figure 1.1 - Real GDP growth
Figure 1.1 - Real GDP growth   .
Source:  Statistics New Zealand, the Treasury

...with momentum expected to continue in the near term

Annual average growth in real GDP is forecast to remain similar to recent quarters at around 3.5% for the remainder of 2014. Real private consumption of goods and services provides the largest contribution to near-term GDP growth as population and income growth remain strong, followed by residential and business investment. Indicators and outturns for real consumer spending and housing investment suggest a slightly slower pace of growth relative to the Pre-election Update but still solid, in line with elevated business and consumer confidence.

Business investment growth is strong...

Business investment increased 3.9% in the June quarter to be 10.4% higher in the year ended June 2014. Business confidence and activity surveys point to solid, albeit slowing, growth over the year ahead. In coming quarters, investment will be supported by the rebuild in Canterbury, the high value of the NZ dollar and relatively low interest rates, making imported capital goods cheaper and investment more profitable.

...while private consumption and residential investment are forecast to increase further

Likewise, consumer confidence remains elevated, despite easing over the September quarter, pointing to ongoing robust private consumption growth (Figure 1.2). Rapid population growth from net migration inflows and increasing aggregate income as employment expands further will continue to support growth in the near term. Recent indicators of retail spending reinforce the expectation of annual real private consumption growth accelerating to around 3.5% in the second half of 2014.

Figure 1.2 - Consumer confidence and private consumption
Figure 1.2 - Consumer confidence and private consumption.
Source: Statistics New Zealand, Westpac-McDermott Miller

Residential investment is at an historically high level, supported by strong demand in Auckland and Canterbury. Recent data on dwelling consents point to slower momentum over the second half of 2014, with the growth from the Canterbury rebuild more muted than a year ago. A shortage of housing in Auckland owing to under-building in recent years will continue to contribute to residential investment growth for some time.

Strong labour demand led to a further decline in unemployment...

The demand for labour grew strongly in the year to September, with the number of people employed increasing by 72,000 (3.2%). The increase in jobs was evident across most industries. Labour supply has also expanded rapidly over the past year with the working-age population increasing by 63,000 (1.8%). The elevated net inflow of working-age migrants accounts for much of this increase, contributing 1.2 percentage points to working-age population growth in the September year.

The net inflow of migrants in the October year rose to a record 47,700, an increase of 30,200 from the year before. The increase from the previous year has been driven by a fall in the departures of New Zealand citizens to Australia (down 13,300) while the increase in the arrival of non-New Zealand citizens was also a significant contributor (up 12,300).

In addition, the proportion of the working-age population participating in the labour force has been rising, lifting 0.4 percentage points to 69.0% from a year ago. The expansion in labour supply has been more than absorbed by strong employment growth, resulting in a further reduction in spare capacity in the labour market (Figure 1.3). This is reflected in the unemployment rate declining 0.7 percentage points from the September quarter last year to 5.4%, maintaining the downward trend observed over the past two years. Employment growth is forecast to ease slightly, but remain at a moderate rate in coming quarters, which is expected to keep the unemployment rate steady.

Figure 1.3 - Employment and labour force growth and the unemployment rate
Figure 1.3 - Employment and labour force growth and the unemployment rate   .
Source:  Statistics New Zealand

...and increases in labour incomes continue to support growth in real consumption...

While spare capacity in the labour market has narrowed, annual growth in average hourly earnings for the private sector remained broadly steady at 2.9% in the September quarter. On the other hand, growth in average hourly earnings for the public sector continues to be low at 1.0%, reflecting fiscal restraint. Average hourly ordinary-time earnings for all sectors rose 2.3% annually. Growth in average hourly earnings has been accompanied by growth in hours paid (up 2.6%), resulting in gross weekly earnings increasing 5.0% from a year ago.

Modest CPI inflation of 1.0% in the September year suggests solid real labour income growth which supports the near-term outlook for increased real consumption growth. Wage growth is expected to increase as reduced spare capacity bids up wages. However, strong growth in labour supply from net migration, low inflation and continuing public sector wage restraint suggest wage growth is likely to remain moderate. Annual growth in average hourly wages is forecast to increase to 2.8% by the March 2015 quarter from 2.3% in the September 2014 quarter.

...while activity in the housing market has moderated

The turnover of existing houses has eased from late last year, in part owing to the introduction of loan-to-value restrictions and a rise in the OCR of 100 basis points between March and July 2014. Annual growth in house prices slowed from just less than 10% in late 2013 to 3.9% in October 2014 (Figure 1.4), while house sales in the three months to October were down 10.2% on last year. The contribution of net migrant inflows to housing demand to date appears to have been weaker than in previous migration cycles. This may reflect the composition of the net inflows with the increase in arrivals over the past year dominated by students and temporary workers who together accounted for around two-thirds of the increase. These categories of migrants typically rent accommodation and are therefore less likely to add to the demand for owner-occupied housing relative to migrants arriving on residency visas.

Figure 1.4 - House sales and house price growth
Figure 1.4 - House sales and house price growth   .
Source:  Real Estate Institute of New Zealand (REINZ)

Despite the moderation in national house prices over the first half of 2014, annual house price inflation remained high in Auckland and Canterbury at 9.8% and 9.1% respectively in October and national house sales have increased since the middle of this year. Low funding costs and an ample supply of deposits in New Zealand are allowing banks to keep fixed mortgage rates at historically low levels, supporting housing demand. Low fixed-term mortgage rates, combined with elevated net migrant inflows, are expected to result in house price inflation increasing to around 5% in coming quarters.

Trading partner growth remains uneven...

The outlook for trading partner growth remains positive in the December 2014 year at 3.7% but is uneven with strong growth in the US and the UK but weaker growth in Japan and the euro area, while Australia's growth has fallen below trend on a quarterly basis. The US economy continues to recover as economic growth rebounded strongly in the middle of 2014 from the weather-affected March quarter. On the other hand, growth in China eased in the September quarter, partly reflecting the slowdown in the housing market. Inflation is also subdued in most developed economies, particularly in the euro area and in Japan where demand has been weak, prompting further monetary policy easing.

...and the outlook for the terms of trade has weakened...

The terms of trade for goods and services on a SNA basis declined 2.1% in the June quarter from their peak but remained 9.7% higher than a year ago.[1] This fall was driven by a 3.6% decline in export prices in the June quarter, with the fall broad-based across most commodities, while import prices fell 1.5%. A further fall in the terms of trade is expected in the September quarter.

The price for dairy products has continued to fall rapidly since February of this year and the outlook over the next few months remains weak. Price falls at the GlobalDairyTrade (GDT) auction accelerated from early August, when Russia imposed an import ban, with average auction prices falling 17% since then. Overall, dairy prices at the auction at the beginning of December were around 50% below their February peak but are expected to begin recovering over 2015, although downside risks remain to this forecast. Although the direct effects of lower dairy prices have been limited to date, export revenues are expected to decline significantly in coming quarters, resulting in reduced spending in the dairy sector and the rural economy more generally. For further detail on dairy price developments, see the box on page 13.

Forestry prices have also declined as demand from China has fallen with slower growth in housing construction, manufacturing and exports. The declines in dairy and forestry export prices have been partly offset by higher meat export prices, owing to additional demand from China and constrained beef supply in the US. International crude oil prices have also fallen significantly. The average Brent crude oil price in the two months to November was down 17% from the September quarter, reflecting an easing in global demand and increased production in the Middle East and the US. Lower oil import prices should contribute to less inflation in the December quarter through reduced petrol prices which will benefit consumers and provide some offset to the negative income effects of lower dairy prices.

Given recent developments in dairy auction prices, the merchandise terms of trade are expected to decline further than forecast in the Pre-election Update. The decline in market prices since the March 2014 quarter is expected to result in a 15% fall in the merchandise terms of trade in the year to March 2015 (Figure 1.5).

Figure 1.5 - Goods terms of trade (SNA)
Figure 1.5 - Goods terms of trade (SNA)   .
Source:  Statistics New Zealand, the Treasury

Notes

  • [1]The terms of trade are the ratio of New Zealand's export prices to import prices and reflect the quantity of imports the economy can buy for a unit of exports (ie, an increase in the terms of trade indicates an increase in purchasing power as well as increased income for the economy).
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