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Pre-election Economic and Fiscal Update 2014

Medium-term Outlook

Fundamental drivers of outlook unchanged

The medium-term growth outlook is largely unchanged from the Budget Update. The drivers of growth are expected to be a surge in residential construction in Auckland and Christchurch, higher net migration and historically high terms of trade despite some near-term adjustment. These factors are expected to be reinforced by continuing strong labour income growth, leading to increasing private consumption.

The initial above-trend growth will place further pressure on labour and capital resources, leading to increased inflationary pressures and higher interest rates. Growth will also be moderated by a continuing high value of the NZ dollar and fiscal restraint. The current account deficit is forecast to increase from its current low level as import values grow faster than exports.

Figure 1.7 - Nominal GDP
Figure 1.7 - Nominal GDP   .
Source:  Statistics New Zealand, the Treasury

While growth in real GDP in the March 2015 year is forecast to be slightly lower than in the Budget Update, the outlook is very similar over the rest of the forecast period. In terms of nominal GDP, growth is expected to be slightly lower in the March 2015 year and similar thereafter (Figure 1.7). The level of nominal GDP is forecast to be approximately 0.5% lower than in the Budget Update over the forecast period as a whole.

Terms of trade to stabilise above historical average...

Although the goods terms of trade are expected to fall 10% in the year to March 2015, they are forecast to stabilise at around that level and to be 9% higher over the forecast period than their average over the past decade. They are expected to be chiefly supported by continuing robust demand from China for dairy and meat products. Demand for forestry products will pick up again with an increase in construction activity in China and residential construction in the US and Australia. Demand for New Zealand's other primary commodities, and for manufactured products, is expected to be sustained by the gradual recovery in the world economy.

...but NZ dollar to decline, making some exports more competitive

The value of the NZ dollar is assumed to remain close to its record level on the TWI in the near term, supported by relatively high commodity prices and positive interest rate differentials. It is expected to begin to decline as the economic recovery becomes more established in the US and the Federal Reserve starts to increase its policy rate, gradually reducing the interest rate differential. The impact of an earlier and more rapid decline in the NZ dollar as a result of a faster recovery in the US economy is discussed in the Risks and Scenarios chapter.

The fall in the NZ dollar is expected to boost tourism earnings and manufactured exports as NZ dollar-priced goods and services become more competitive. The TWI is assumed to decline from an average of 81.2 in the current quarter to 73.3 in the June quarter of 2018, a fall of 9.7% over four years.

Residential investment a major driver of growth in the economy...

The rebuilding of residential housing in Christchurch is forecast to be a major driver of growth in real GDP at the start of the forecast period and then to help sustain the level of activity. Annual growth in residential investment is forecast to peak in the December quarter 2014, but the level of activity is forecast to continue to increase throughout the rest of the forecast period.

The assumptions concerning the rebuilding of Christchurch are unchanged from the Budget Update. The total amount of rebuild-related investment is estimated to be $40 billion (in 2011 prices), with around half of this total assumed to take place by mid-2018. Most of this investment will be funded by insurance payments and government investment. Residential investment is expected to provide the greatest contribution over the forecast period, followed by investment in infrastructure and social assets, and commercial assets.

...along with business investment

Businesses are also expected to continue to expand their investment as aggregate demand in the economy increases. As noted above, business confidence and investment intentions are at high levels, although they have eased from earlier in the year. Reduced spare capacity in the economy, continuing high terms of trade and a tighter labour market are expected to lead firms to invest more. Annual average growth in business investment is forecast to remain high until mid-2015, and then to decline to be similar to GDP growth by the end of the forecast period.

Higher net migration boosts population growth...

Figure 1.8 - Net external migration
Figure 1.8 - Net external migration   .
Source:  Statistics New Zealand, the Treasury

The net external migration inflow has been running ahead of the Budget Update forecast as departures declined. The forecast peak annual gain in September 2014 has been increased from 38,100 in the Budget Update to 42,500 in these forecasts (Figure 1.8); the turn-around in net migration inflows in 2015 is now assumed to be slightly sharper than previously as departures start to increase again with a pick-up in the Australian economy and arrivals begin to fall as the demand for labour eases. The small change in the profile of migration results in an additional 3,500 people in the total population compared with the Budget Update. Higher net migration inflows would pose an upside risk to the outlook.

...and increased demand for workers results in a fall in unemployment...

Figure 1.9 - Participation and unemployment
Figure 1.9 - Participation and unemployment   .
Source:  Statistics New Zealand, the Treasury

The demand for labour is expected to continue to grow with the expansion in the economy. Employment growth is forecast to remain strong over the remainder of 2014, but to ease as the pace of growth in output slows. Growth in the working-age population will be boosted by higher net migration and the proportion of the working-age population participating in the labour market is forecast to decline only slightly from its March quarter peak. As a result, the unemployment rate is forecast to fall to 4.5% in the first half of 2018 (Figure 1.9).

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