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Half Year Economic and Fiscal Update 2015

Recent Developments and Near-term Outlook

Economic growth has slowed...

The pace of economic expansion slowed during the first half of 2015 owing to weaker international and domestic demand and falling dairy prices. This led to more spare capacity in the economy, reflected in low non-tradables inflation and higher unemployment. Weaker demand is expected to lead to slower annual growth over the remainder of 2015 and into 2016. Real production GDP growth is expected to slow from 3.2%in the year to March 2015 to 2.1% in the year to March 2016 (Figure 1.1). Although real GDP growth was lower than forecast in the Budget Update in the year to June 2015, nominal GDP growth was higher. As a result, nominal GDP was $0.8 billion higher than forecast, contributing to higher tax revenues in the 2015 fiscal year.

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

…with several developments impacting the economy and its outlook

A number of key developments since the Budget Update have influenced the revisions to the near-term growth outlook. These include a more subdued and uncertain global outlook, falling commodity prices (dairy in particular) contributing to a lower terms of trade, an earlier than expected peak in the Canterbury residential rebuild and the onset of El Niño. These are partially offset by a number of positive developments, including stronger net migration and tourist arrivals, higher housing market turnover and more stimulatory monetary conditions.

Judgements around trading partner growth, the future path of commodity prices, the impact of El Niño, the extent and duration of the current migration cycle and the relationship between inflation and spare capacity are key factors influencing the economic outlook. These judgements and the risks around them are discussed further in the Risks and Scenarios chapter and in the migration and El Niño boxes on pages 15 and 20.

Global economic growth has slowed…

Global economic growth has slowed over 2015 as demand weakened in China, impacting on other developing economies and slowing the recovery in many developed economies. The exception to these developments is the continuing recovery in the US economy.

Slower global growth is chiefly a result of the weaker economic outlook for emerging economies. Growth has slowed in China as the economy transitions from the investment-led model of recent years to greater dependence on consumption as a driver of growth, and as authorities balance structural reform and short-term stimulus of the economy. Sharp declines in the share market and adjustments to the exchange rate mechanism caused additional concerns about future growth mid-year. Slower growth in China has had flow-on effects to other economies in Asia, many of which are key trading partners for New Zealand, as well as commodity exporters such as Canada, Brazil and Russia.

The slowdown in China has also affected the Australian economy through a further fall in its terms of trade. However, with lower interest rates and a lower value of the Australian dollar, the Australian economy is shifting from mining investment towards other areas of investment (including housing), private consumption and export volume growth (both goods and services) as the main drivers of demand.

Economic indicators in both the US and UK have remained largely upbeat throughout 2015, although there has been some loss of momentum recently in the UK. Growth has been more subdued in Japan and the euro zone, with both economies easing monetary policy further through quantitative easing. Concerns over Greece's sovereign debt have decreased since mid-year.

Slower global growth has been reflected in weak commodity prices. Oil prices have remained low throughout the year, having fallen by 50% in the latter part of 2014. Since July, WTI oil prices have remained below US$50/barrel. The Commodity Research Bureau Futures Index has fallen 45% from a year ago and is just above a 14-year low.

…as has domestic demand

Domestic demand was weak through the first half of 2015. Real GDP (production measure) rose 0.2% and 0.4% in the March and June quarters respectively. Household consumption growth was particularly soft, largely owing to weak services consumption growth. In addition to low consumption growth, there was reduced impetus from the Canterbury rebuild and lower mining-related investment (in response to lower oil prices).

There are some positive factors underpinning growth despite recent weakness. Although there has been slower growth in the Canterbury residential rebuild, construction activity has remained solid. Services industries have also continued to grow at a steady rate, supported in part by a 25.6% increase in travel services export values in the year to June 2015 (mostly tourism- and education-related). Activity in the housing market has increased, driven by a higher number of sales in Auckland and, more recently, surrounding regions.

Aggregate demand has been supported by high levels of net inward migration, which reached a record 62,500 in the year to October 2015. The drivers of migration and the impacts on the economy are discussed in more detail in the box on page 15.

Dairy prices remain at low levels...

Dairy prices rallied briefly at the start of 2015 on concerns that drought might curb New Zealand milk production. However, once it became apparent that drought had not significantly reduced New Zealand production and that global demand remained relatively subdued, dairy prices fell sharply on the GlobalDairyTrade (GDT) auction platform. Between March and August prices fell by 50%, with key product whole milk powder selling for as low as US$1,600/mt in August.

Prices have recovered somewhat since then, albeit from a very low base, and by mid-November the GDT average price was around US$2,500/mt (Figure 1.2). This has led to a significant drop in dairy farmgate prices and incomes across both the 2014/15 and 2015/16 seasons, with many farmers projected to have negative cash flows in the latter season. The large drop in dairy farm incomes has spill-over effects to the wider economy as well.

Figure 1.2 - Dairy prices
Figure 1.2 - Dairy prices   .
Source:  GlobalDairyTrade, Statistics New Zealand, the Treasury

...but have been partly offset by strength in other export prices and lower import prices

While dairy export prices have fallen sharply, New Zealand's other exports such as meat, horticultural and seafood products, and manufactured goods have held up better and have benefited from depreciation of the New Zealand dollar (discussed further below). At the same time, world prices for New Zealand's imports have also remained relatively low. In part this reflects low global inflation. New Zealand has also benefited from low oil prices. Taken together, these factors saw New Zealand's terms of trade rise over the first half of 2015 despite the weakness in dairy prices, which will be reflected in the terms of trade in the second half of the year.

Slower economic growth has led to lower inflationary pressures and higher unemployment...

Inflation has remained low, at 0.4% in the year to September 2015 (Figure 1.3). Non-tradables inflation eased to 1.5%, reflecting a greater degree of spare capacity in the economy as well as policy changes (chiefly the ACC vehicle levy reduction). Subdued non-tradables inflation has been offset by slightly higher tradables inflation in recent quarters, resulting from a weaker New Zealand dollar. That said, annual tradables inflation remains negative at -1.2%, indicative of weak global inflationary pressures as well as the lagged impact of the previously high dollar.

Figure 1.3 - Consumer price inflation
Figure 1.3 - Consumer price inflation .
Source: Statistics New Zealand

Labour market movements also reflect the greater degree of spare capacity in the economy. Employment growth has eased, resulting in unemployment rising from 5.8% in March 2015 to 6.0% in September 2015. Nominal wage growth remains subdued but is well above the rate of inflation, indicating that growth in real wages has been positive.

...and loosening of monetary policy

In response to the weakening activity and inflation outlook, the Reserve Bank reduced the Official Cash Rate (OCR) by 75 basis points between June and September, to 2.75%, and retained an easing bias in October. Easier monetary conditions together with the decline in export prices have been associated with a depreciation of the New Zealand dollar. The trade-weighted exchange rate has fallen by about 10% since April.

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