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Pre-Election Economic and Fiscal Update 2008

Economic and Tax Outlook (continued)

Assumptions for the Forecasts

Trading partner growth - Consensus forecasts for economic growth in New Zealand's top 20 trading partners in 2008 and 2009 have been revised down steadily over the course of 2008. In anticipation of further revisions, we have reduced the August Consensus forecasts from 3.1% and 3.0% in 2008 and 2009 (respectively) to 2.9% and 2.8%. Growth is estimated to recover subsequently to around 3.5%. Recent developments in financial markets since these forecasts were finalised on 28 August have increased the risks of further downward revisions in the forecasts. The Risks and Scenarios chapter presents a case based on lower world growth.

Global inflation and interest rates - Inflation has increased in all our major trading partners as a result of rising food and fuel prices but is expected to decline as these prices stabilise or fall. Despite higher inflation, policy interest rates have been lowered in all major economies except Japan and the Euro area in response to the financial crisis and weaker economic growth. Commercial interest rates, however, are higher as inter-bank rates have increased. Interest rates are expected to return to neutral levels by 2010.

Figure 1.2 - West Texas Intermediate oil price
Figure 1.2 - West Texas Intermediate oil price.
Source:  Datastream, The Treasury

Oil prices - We have assumed that the price of West Texas Intermediate (WTI) oil will decline from an average of US$124/barrel in the June quarter of 2008 to US$115/barrel at the end of the forecast period. These forecasts were based on the average futures prices in August 2008 and average 13% higher throughout the forecast period than in the Budget Update (Figure 1.2). Since the end of August, the price of WTI has fluctuated widely, showing the increased uncertainty associated with these forecasts.

Terms of trade - The merchandise terms of trade (as measured in the System of National Accounts) are estimated to have peaked in the March quarter of 2008 and to decline 7.0% in the following five years as commodity prices fall from their peaks. The terms of trade are approximately 1.5% lower throughout the forecast period than in the Budget Update mainly because of lower dairy prices and higher oil prices.

Monetary conditions - We have assumed that the New Zealand dollar (NZ dollar) exchange rate will decline 22.7% from 69.2 on the Trade Weighted Index (TWI) in the June quarter of 2008 to 53.5 at the end of the period. Ninety-day interest rates are assumed to fall from 8.8% in the June quarter of 2008 to 6.3% at the end of the period. These forecasts were finalised before the Reserve Bank reduced the Official Cash Rate by 50 basis points on 11 September 2008. That may hasten the fall in interest rates in the near term.

External migration - The net inflow of permanent and long-term migrants is assumed to increase from a low of 4,700 in the year to June 2008 to its 10-year average of 10,000 per annum by March 2010 as outflows, particularly to Australia, ease and inflows, including returning New Zealanders, increase as economic growth slows elsewhere.

Policy and tax - The forecasts assume no change in government policy and incorporate the tax cuts effective from 1 October 2008 and 1 April 2010 and 2011, as did the Budget Update.

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