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Pre-election Economic and Fiscal Update 2014

Recent Developments and Near-term Outlook

Outlook for economic growth similar to Budget Update...

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

Real production GDP grew 3.3% in the year to March 2014 from the previous year, slightly faster than the 3.0% forecast in the Budget Update (Figure 1.1). Growth in the March quarter was marginally higher than forecast at 1.0%, but most of the difference in annual average growth was accounted for by upward revisions to earlier quarters' previously published growth rates. The outlook for annual average growth in real GDP in the year ahead is 3.8% (slightly lower than the 4.0% in the Budget Update), easing to 3.0% in March 2016 and 2.1% in March 2018.

...but private consumption was lower than expected in the March quarter...

Although outturns at an aggregate level for the March quarter were only slightly higher than forecast, there were some significant differences within the components of economic activity. The level of real private consumption was unchanged from the previous quarter, which was well below the Budget Update forecast of 0.8% growth, with the demand for services down by 0.4% in the quarter. The reasons for the weakness are not yet clear but a strong recovery is expected in the June quarter, based on indicators released to date.

Growth in private consumption in current dollar terms was weaker than forecast by a slightly larger margin as consumption prices rose only 0.1% in the March quarter, compared to the Budget Update forecast of a 0.3% increase. Consumer price inflation was lower than expected in the June quarter for non-tradable goods and services, indicating a continuation of weak price pressures in the economy. The annual inflation rate in June 2014 was 1.6%, less than the Budget Update forecast of 1.8%, with non-tradables inflation of 2.7% compared with a forecast of 3.4%.

...offset by higher net exports in both real and nominal terms

Strong growth in exports offset the weak growth in private consumption in the March quarter in both real and nominal terms. Goods export volumes increased 3.9% in the March quarter against an expectation of a slight fall from the December quarter; services exports also increased more than expected, offsetting the weak private consumption outturn.

At the same time, goods import volumes increased by less than forecast, partially offset by higher than expected services imports. As a result, net exports made a larger contribution to GDP than expected. The terms of trade (the ratio of export prices to import prices) were close to forecast so net exports were also higher than forecast in nominal terms.

However, the near-term outlook is for slightly weaker growth...

Although real private consumption is expected to rebound strongly in June from its flat result in the March quarter, it is not expected to recover fully in nominal terms. Consumer price inflation of 0.3% in the June quarter was weaker than forecast in the Budget Update, pointing to weak price growth in the GDP measure of consumption. The level of nominal consumption is expected to remain lower than previously forecast in coming quarters despite ongoing growth in the consumption of goods and services in real terms.

Recent developments in the external sector of the economy reinforce the outlook for slightly weaker than earlier forecast GDP growth in the year ahead. The value of merchandise exports fell in the June quarter with both volumes and prices lower, and import volumes appear to have increased, supporting the forecast negative contribution from net goods exports to real GDP; similarly, although visitor arrivals were up slightly in the June quarter from March, resident departures increased by more, pointing to weak net services exports.

...as weaker terms of trade compound the impact of lower domestic prices

Dairy prices have declined sooner than expected in the Budget Update and these forecasts bring forward the fall in prices. The decline may be partly seasonal as supply increases in New Zealand and demand dips in China, but increasing global supply and high stock levels in China may also be contributing to the weaker prices. The forecast assumes that prices stabilise at around the same level as in the Budget Update by the end of 2014 as the seasonal factors reverse.

Dairy auction prices have fallen further since finalisation of the forecasts in mid-July, dropping 8.4% in US dollars in early August. Dairy auction prices tend to be volatile and the recent falls may overstate the weakness in demand. However, if the latest prices were sustained, they would pose a downside risk to the main forecast. The impact of a larger fall in the terms of trade is explored in the Risks and Scenarios chapter.

Forestry prices have also declined as demand from China has fallen with slower growth in housing construction. These export price declines have been only partly offset by higher meat prices as sheep meat prices were lifted by additional demand from China and meat supply remains constrained in the US. At the same time, oil prices have increased as geopolitical risks have intensified in the Middle East and Ukraine.

Figure 1.2 - Goods terms of trade (SNA)
Figure 1.2 - Goods terms of trade (SNA)   .
Source:  Statistics New Zealand, the Treasury

The terms of trade are expected to decline sooner than forecast in the Budget Update, although to a similar level (Figure 1.2). There is normally a lag of one to two quarters from auction prices to export prices and the terms of trade, and on this basis the declines in market prices since the March quarter are expected to result in a larger fall in the goods terms of trade in the year to December 2014 of 9%, compared with a fall of 5% over the same period in the Budget Update.

Despite lower commodity export prices, the value of the New Zealand (NZ) dollar averaged 80.2 on the Trade Weighted Index (TWI) in the June quarter, 1.5% higher than the Budget Update assumption. It is assumed to decline only slowly from that level over the next couple of years and to remain higher than previously forecast, keeping tradables inflation lower than otherwise but constraining services and manufactured exports to some degree.

Rapid increase in household income points to strong growth in real consumption...

Other data released since the Budget Update was finalised also point to continuing robust growth in the economy in real terms. Firms' demand for labour grew strongly in the year to June, with total weekly paid hours up 3.6% and the number of people employed up 3.7% (Figure 1.3). The increase in labour input was spread across most industries.

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

The supply of labour also increased rapidly over the past year, partly as a result of gains from external migration. The net inflow of migrants in the year to June 2014 was 38,300, an increase of 30,400 from the year before. The increase was largely a result of a fall in the number of departures of New Zealand citizens to Australia (16,500), but increased arrivals of non-New Zealand citizens (9,300) and of returning New Zealand citizens (3,300) also contributed. Net external migration added around 0.9 percentage points to total population growth in the past year.

In addition, the proportion of the working-age population participating in the labour market increased from 68.1% a year ago to 68.9% in the June quarter, resulting in a total increase in the labour force of 2.8% (Figure 1.3). With the faster growth in the number of people employed, the unemployment rate fell from 6.4% a year ago to 5.6% in June 2014. Average hourly wages increased 2.5% from a year before and, given the large increase in total weekly paid hours, total weekly gross earnings rose 6.3% from a year before. With low inflation recently, this result underpins the outlook for ongoing real consumption growth in the near term.

Figure 1.4 - Migration and house prices
Figure 1.4 - Migration and house prices   .
Source:  Statistics New Zealand, REINZ
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