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Half Year Economic and Fiscal Update 2016

Recent Developments and Near-term Outlook

Economic expansion has continued at a solid pace…

Strength in domestic activity in the latter part of 2015 continued into the first half of 2016, with real GDP growth of 0.9% in each of the March and June quarters, faster than 0.6% expected in the Budget Update.Low interest rates and high levels of inward migration have continued to support private consumption, construction activity and construction-related services. Services exports (chiefly tourism) have remained buoyant despite some moderation in trading partner growth and goods export volumes held up higher than expected in the Budget Update,particularly for dairy, following a less severe impact from drought in 2015.

…with momentum expected to be maintained in the near term…

On a quarterly basis, real GDP growth is forecast to remain around 0.9% in the near term, with annual average growth expected to accelerate, peaking at 3.6% in 2017, faster and sooner than expected in the Budget Update (Figure 1.1). Stronger growth is largely owing to an upgrade to the domestic outlook, and with tourism remaining buoyant. Solid growth in private consumption, market investment and residential investment in the near term will remain supported by low interest rates and high net migration. Public consumption growth is expected to remain moderate in the near term. While government spending on infrastructure and private residential investment may be higher in the aftermath of the recent earthquakes in the Kaikōura region, the impact on the economy is expected to be small at the national level (see Economic and fiscal impacts of the Kaikōura earthquakes on page 6 for further detail). Increased cull in the dairy herd is expected to reduce export volumes in the near term, but with a partial offset from solid growth in other goods exports, including horticulture and wine. Growth among our key trading partners is expected to slow slightly in the near term, with low global inflation and interest rates expected to persist.

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

…underpinned by high inward migration… 

Annual net inward migration rose to around 70,000 in the year to September 2016 which is assumed to represent the peak in the current cycle, broadly consistent with the Budget Update. However, migration is assumed to decline from its peak more gradually than in previous forecasts, with the annual inflow in June 2018 around 26,000 higher than forecast in the Budget Update. Migration, population growth and potential output on page 22 provides detail on this assumption change, along with key drivers of migration, such as economic and labour market conditions in Australia relative to New Zealand. High migration and consequent population growth will remain a driver of growth in the near term, supporting private consumption and residential investment.

Real GDP per capita rose 0.7% in the year ended June 2016, up from 0.5% in the previous quarter, but below the average of 1.5% for the past five years. GDP per capita is expected to rise to 1.7% in the year ended June 2018, reflecting the solid pace of expansion in the economy.

…and low interest rates…

Accommodative monetary policy has continued to support demand, with the Reserve Bank reducing the Official Cash Rate (OCR) a further 25 basis points (bps) to 1.75% in November. Since June 2015, the OCR has been reduced a total of 175 bps, leading to a similar decline in short-term interest rates. Floating mortgage rates have come down around 100 bps, as offshore credit conditions have tightened and increased competition for deposits has driven up commercial banks' funding costs.

In its November 2016 Statement, the Reserve Bank stated that current monetary policy settings are sufficient to return inflation to the middle of the target band by late 2018. These forecasts also assume no further easing in the near term, although a number of risks remain that could lead to further easing. Scenario One in the Risks and Scenarios chapter provides an example where such risks eventuate and the OCR is reduced further.

…which drive housing demand and construction activity…

Strong house price growth resumed in 2016 following a brief slowdown in late 2015 (owing to tighter lending conditions for investors)[1] as solid demand for housing, driven by population growth and low mortgage rates, has continued against the backdrop of a shortage in supply. House price growth has increasingly been driven by regions outside Auckland, as buyers look for more affordable options outside the city and where lending conditions for investors had not been tightened as much. In response to high demand for housing, residential investment grew 8.2% in the year to June 2016, significantly stronger than expected in the Budget Update and led by strong activity in Auckland. Strong consents issuance in recent months suggests that activity will increase further (Figure 1.2). Annual residential investment growth rises to a peak of 15.3% in the March quarter 2017 and moderates thereafter.

Figure 1.2 - Real residential investment and dwelling consents
Figure 1.2 - Real residential investment and dwelling consents.
Source: Statistics New Zealand, the Treasury

In Auckland there is scope for building consents issuance to rise further as the Auckland Unitary Plan (AUP) takes effect and loosens regulatory constraints on development and, in the longer term, increases the availability of residential land. However, the AUP still faces significant challenges in its implementation and is not expected to have a significant impact on residential development in the near term.

Strong activity in housing has been reflected in growing household debt, which has reached 165% of household disposable income. If income growth were to slow significantly or if interest rates were to rise sharply, debt servicing could become difficult for some households. This has the potential to constrain GDP growth as households adjust by reducing consumption and residential investment. See the Risks and Scenarios chapter for further discussion.

Market investment grew strongly in the June 2016 quarter as strength in the construction sector was complemented by a broader pick-up in business confidence and lower interest rates. However, lower investment in mining and oil exploration provided some offset. Real market investment is expected to remain solid in the near term, reflecting the large programme of construction work.

…supporting employment growth and private consumption

Figure 1.3 - Real private consumption
Figure 1.3 - Real private consumption   .
Source: Statistics New Zealand, the Treasury

Strong construction and tourism activity has continued to drive growth in employment. Even with net migration inflows and the participation rate at record highs, labour demand has kept pace with supply and the unemployment rate has been broadly stable at around 5%.[2] Nominal wage growth has been muted, reflecting ample labour supply growth and employment growth concentrated in less productive sectors. However, with slow growth in consumer prices, real wages have continued to grow at a steady pace. That said, aggregate nominal income growth has been solid as total hours worked have increased strongly. More people active in the labour market and earning higher incomes has translated into strong private consumption growth.

These factors are expected to persist in the near term, with private consumption stronger than in the Budget Update (Figure 1.3). In addition, solid consumption growth will be supported by low interest rates and increased spending on durable goods, reflecting the strong outlook for residential investment.

The Government's fiscal strategy of restrained public spending growth and reducing debt means growth in public consumption will remain modest in the near term. Accordingly, government spending is estimated to have a mildly stimulatory impact on aggregate demand over the next two years, but is broadly neutral over the forecast period on average.[3] In addition, fiscal spending associated with the recent earthquakes (discussed on page 6) is expected to have a relatively small impact on aggregate demand.

Notes

  • [1] The Reserve Bank increased loan-to-valuation ratio restrictions for loans secured by investment property in Auckland to 60% in November 2015. In October 2016 this was extended nationwide, reducing investor housing demand in the September quarter as the restrictions were applied in advance. For further detail, see http://www.rbnz.govt.nz/financial-stability/loan-to-valuation-ratio-restrictions
  • [2] Recent changes to the Household Labour Force Survey make interpretation of employment data less clear. See Implications of changes to the Household Labour Force Survey on page 15 for further details.
  • [3] The fiscal impulse, a measure of the impact of fiscal settings on demand, is discussed in Structural fiscal balance indicators on page 40.
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