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Pre-Election Economic and Fiscal Update 2008

Economic and Tax Outlook (continued)

Weaker Growth as Global Economy Adjusts to Imbalances

The global economy is adjusting to significant imbalances

Figure 1.3 - World commodity prices
Figure 1.3 - World commodity prices.
Source:  Commodity Research Bureau, Goldman Sachs

High consumption growth in developed economies in recent years and increased production in developing economies led to developing economies building up large trade surpluses which provided funding for the rapid growth in the developed economies. The greater integration of low-cost developing economies into the world trade system helped suppress inflation and allowed interest rates to become established at low levels, encouraging investment in housing and inflating house prices. The search for higher yields led investors to under-estimate the risks of some investments. At the same time, growth in the developing economies was resource-hungry, pushing up commodity prices (Figure 1.3).

The sub-prime mortgage crisis, which developed in the United States (US) in mid-2007, was the trigger for the unwinding of these imbalances and the world economy, especially the US economy, is now undergoing the necessary adjustment. House prices have fallen in many countries and market interest rates have increased. High commodity prices, particularly for food and fuel, are impacting on household budgets in both developed and developing economies. Production costs are increasing in the developing economies, making them a source of inflation rather than deflation in the world economy. Trade imbalances are being corrected as the pattern of growth in developed economies shifts away from consumption towards exports. This process of adjustment is expected to be protracted and to involve both developing and developed economies.

Performance of the Australian economy is key for New Zealand

So far, these developments have had little direct impact on the New Zealand economy. In this regard, the performance of the Australian economy is particularly important for New Zealand as it is our largest single merchandise trade export market, our main tourist market, the top destination for emigration and our main investment partner. In addition, our major retail banks are Australian-owned. The Australian economy has performed strongly until recently, but it is currently undergoing a significant re-appraisal as the domestic economy slows despite the high terms of trade resulting from the continuing strong demand from China and other emerging economies for mineral resources. Any slowdown in the Australian economy arising from the global financial crisis is likely to have a direct impact on the New Zealand economy.

Since our forecasts were finalised at the end of August, there have been further developments in the global financial crisis, particularly in the US. These developments increase the downside risks to these forecasts. The Risks and Scenarios chapter discusses these risks in more detail and develops a scenario based on lower world economic growth.

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