Statement 3: Economic Outlook
- Key assumptions
- Demand and output
- Net exports and the current account deficit
- Labour Market, Wages and Prices
Part III: The outlook for the domestic economy
Key assumptions
In line with usual practice, the exchange rate is assumed to remain unchanged from the average levels reached in recent months, at around US53c and around 52 against the trade weighted index (TWI). The assumed continued very competitive level of the exchange rate over the forecast period is expected to support solid export growth over 2002-03.
Similarly, interest rates are assumed to remain consistent with the existing monetary policy framework, and at levels which are supportive of domestic demand, especially business investment, residential investment and household consumption spending.
An assumption of average seasonal conditions is expected to drive a slight pick up in growth of farm production in 2002-03.
Demand and output
In 2002-03, economic growth in Australia is forecast to be around 3¾ per cent in year-average terms and a strong 4 per cent through the year to the June quarter 2003. The unemployment rate is forecast to decline slightly from recent levels to be around 6 per cent in the June quarter 2003. Inflation is expected to be around 2¾ per cent in year-average terms in 2002-03 and around 2½ per cent through the year to the June quarter 2003, within the medium-term target band of 2-3 per cent. The current account deficit is forecast to widen slightly to around 4 per cent of GDP, continuing below its average level of the 1990s.
The Australian economy's resilience during the global slowdown has attracted considerable attention. In contrast to most of the rest of the world, economic growth in Australia strengthened over 2001. While weaker world growth did lead to a moderation in export growth, domestic activity has been supported by robust household consumption growth and a sharp rebound in investment in residential construction following the temporary slowdown in this sector during the second half of 2000. Economic growth is expected to be around 3¾ per cent in 2001-02, an upward revision to the 3 per cent growth forecast presented in the Mid-Year Economic and Fiscal Outlook 2001-02, which was prepared in the immediate aftermath of the events of 11 September 2001. The IMF and OECD both forecast Australian economic growth to be among the highest of developed economies in 2002 and 2003.
Domestic demand is expected to strengthen over 2002-03, with gross national expenditure forecast to grow by a very strong 4¾ per cent in year-average terms, following expected strong growth of 4¼ per cent in 2001-02. There is likely to be some change in the main drivers of domestic demand over 2002-03, with a strong pick up in business investment and continued robust household consumption expected to more than offset subdued activity in residential construction (Chart 2).
Following relatively subdued activity over recent years, business investment is expected to rebound strongly in 2002-03, supported by low interest rates, solid profitability and high business confidence, while improving employment levels should support continued robust household consumption growth. Dwelling investment is expected to post a small decline in 2002-03, as the normal cyclical factors reassert after the bring forward of building related to the enhanced First Home Owners Scheme is completed. Not all of the increase in domestic demand will be met by domestic production (GDP), with net exports expected to be weaker. Despite a solid rebound in export growth, strong domestic demand, particularly in the more import-intensive sectors of the economy such as plant and equipment investment, will lead to even stronger growth in imports.
Chart 2: Contributions to GDP growth(a)
(a) Adjusted for second-hand asset sales as noted in Table 1.
Source: ABS Cat. No. 5206.0 and Treasury.
Household consumption
Household consumption is forecast to increase by around 3¾ per cent in 2001-02 and 4 per cent in 2002-03 (Chart 3). This is expected to return growth to a little above trend rates after very subdued growth in the first half of 2000-01.
Chart 3: Annual growth in real household consumption
Source: ABS Cat. No. 5206.0 and Treasury.
Consumer spending grew strongly in 2001 despite only modest growth in real household disposable income through this period. Consumption was assisted, in part, by the boost to household spending power generated by low interest rates, strong dwelling investment which boosted consumption of durable goods, declining petrol prices and strong growth in household wealth. Household interest expenses fell in 2001 as official interest rates were cut six times, by a cumulative 2 percentage points. Consumers also saved on petrol outlays as the automotive fuel component of the CPI fell by 12 per cent over the year to December 2001. Strong gains in household wealth - established house prices rose strongly by 16 per cent over the year to the December quarter 2001 and the local share market recovered to near record highs - also assisted in maintaining solid consumption spending.
Growth in real household disposable income is expected to increase to around trend rates in the forecast period, in line with improved labour market conditions. In contrast, higher world oil prices have seen petrol prices increase steadily in the first four months of 2002. There is a risk that petrol prices may have a moderating impact on household consumption if external developments lead to sustained higher oil prices. In addition, following the rapid increases in established house prices over recent years, it is assumed that gains in household wealth from this source will be closer to trend in the period ahead. On balance, overall growth in household spending power, assisted by low interest rates and improved labour market conditions, is expected to be supportive of consumption growth over the forecast period.
Consumer confidence, as measured by the Westpac-Melbourne Institute index, is currently at a relatively high level, providing further support for the consumption outlook (Chart 4).
Chart 4: Westpac-Melbourne Institute consumer sentiment index
Source: Westpac-Melbourne Institute.
The household sector's financial position remains sound despite an expansion in household debt levels during the last decade.2 The increase in household borrowing over recent years largely reflects an increase in affordability brought about by low interest rates and the continuing impact of financial deregulation on the availability of credit. The build-up in debt has led to a significant increase in the ratio of household debt to disposable income (Chart 5), bringing this ratio to levels more comparable to those in other developed countries (Chart 6). However, household assets have also grown strongly in recent years, with the household debt-to-asset ratio showing only a gradual increase (Chart 7). Further, households' current ability to service debt is high. Household interest payments are now around 6¼ per cent of disposable income, down from a peak of around 12 per cent in 1989-90 (Chart 8). Although the position of overall household balance sheets is sound, the expansion in household debt has left the sector more exposed to increases in interest rates and declines in asset prices. In addition, while household debt ratios are not a cause for concern in the near term, sustained further increases in debt-to-income ratios would increase sensitivity to interest rate and asset price movements.
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Chart 5: Household debt (per cent of disposable income)
Source: Reserve Bank of Australia (RBA). |
Chart 6: Household debt, international comparisons (per cent of disposable income)
Source: RBA, OECD, Reserve Bank of NewZealand and Treasury. |
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Chart 7: Household
Source: ABS Cat. No. 5204.0 |
Chart 8: Interest payments (per cent of disposable income)
Source: ABS Cat. No. 5206.0 |
Dwelling investment
Following estimated very strong growth of around 16 per cent in 2001-02, dwelling investment is forecast to decline by 3 per cent in year-average terms in 2002-03 (Chart 9).
Dwelling investment rebounded sharply from the temporary slowdown in the second half of 2000 to be a key driver of GDP growth in 2001-02. The sharp turnaround in the residential construction sector was driven by historically low mortgage interest rates and the Government's more generous First Home Owners Scheme (FHOS) for new (rather than established) dwellings. The more generous FHOS provided a targeted, short-term boost to building activity. It is now being phased out at a time of strength in the sector and the economy more generally.
Chart 9: Annual growth in dwelling investment
Source: ABS Cat. No. 5206.0 and Treasury.
In 2002-03, dwelling investment is expected to decline moderately by around 3 per cent, driven by a significant fall in new dwelling investment, partly offset by ongoing growth in expenditure on alterations and additions. The forecast decline in new dwelling investment comes as FHOS-related bring forward of building is completed. FHOS data to March 2002 indicate that the take up of the additional (total grant of $14,000) and phased-down (total grant of $10,000) grants has been extremely strong (Chart 10). This suggests that a significant amount of residential building activity has been brought forward and will subsequently unwind over the course of 2002-03.
The 2002-03 forecasts also incorporate some reduction in the significant stock of excess supply that has developed in some segments of the dwelling market. Evidence of excess supply has emerged in the market with vacancy rates, particularly for medium/high density dwellings in Sydney and Melbourne, rising significantly through the year to December 2001 to around historically high levels.
Ongoing growth in expenditure on alterations and additions is expected to moderate the overall decline in dwelling activity in 2002-03, supported by low interest rates, solid employment growth and recent gains in household wealth. While past activity in alterations and additions moved broadly in line with new dwelling construction, there are grounds to believe that alterations and additions will continue to grow over the forecast period, notwithstanding a downturn in new dwelling construction. This is because the downturn in new dwelling construction principally relates to the phasing out of the additional FHOS. Overall conditions remain supportive of the outlook for alterations and additions.
Chart 10: FHOS grants for new dwellings
Source: Treasury.
The forecast overall modest decline in dwelling investment in 2002-03 is likely to have flow-on effects for other areas of the economy. Specifically, employment is expected to fall in this labour intensive sector, while sales of durable goods typically associated with the purchase of a new dwelling are also likely to moderate.
Business investment
New business investment3 is forecast to grow by a very strong 12 per cent in 2002-03, following expected growth of around 4 per cent in 2001-02, and a fall of 3.1 per cent in 2000-01 (Chart 11). The very positive outlook for business investment reflects strong fundamentals: low interest rates; the competitive level of the exchange rate, which continues to support Australia's export and import-competing sectors; the reduction in the company tax rate; and corporate profitability, which is above longer-run averages as a percentage of GDP and is particularly strong in the rural and mining sectors.
The subdued business investment levels of the last two years have resulted in above average capacity utilisation, particularly in the mining industry. Business sentiment has also strengthened significantly in recent months, rebounding from the impact of the 11 September 2001 terrorist attacks, and buoyed by an expected recovery in the world economy. Virtually all business surveys have shown a relatively strong improvement in business confidence and investment intentions.
Chart 11: Annual growth in new business investment(a)
(a) Excluding net purchases of second-hand public sector assets by the private sector.
Source: ABS Cat. No. 5206.0 and Treasury.
New investment in machinery and equipment is expected to grow by a very strong 12 per cent in 2002-03, following expected subdued growth of around 3 per cent in 2001-02, and essentially no growth in 2000-01. The outlook is partly driven by an expected substantial strengthening in mining investment (Box 1). After a couple of very weak years during and immediately following the Asian financial crisis, conditions in the mining sector are conducive for strong investment, with record levels of profitability boosted by the competitive level of the exchange rate and higher world prices for some key export commodities. Equipment expenditure intentions are also very strong in the transport and storage sector, which partly reflects scheduled new investment by the aviation industry.
The latest Australian Bureau of Statistics (ABS) capital expenditure survey showed that firms' first estimate of plant and equipment investment intentions for 2002-03 were very strong, although early estimates only provide a broad indication of likely outcomes. While investment intentions have picked up strongly across several sectors, intentions in other areas, especially some parts of manufacturing, remain subdued.
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Box 1: Investment in the mining industry |
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The mining industry accounts for around 5 per cent of Australian GDP, but contributes around 35 per cent of total export earnings and around 12 per cent of new business investment expenditure. Mining is one of Australia's most capital-intensive industries, with about $1.4 million of capital stock per employee - around five times the average across industries. Chart A: Mining contribution to new business investment
Source: ABS Cat. No. 1364.0.15.003. Prior to the Asian financial crisis, Australian business investment was lifted by a surge in mining investment, which grew by around 81 per cent in the four years to 1997-98. The onset of the Asian financial crisis saw mining investment fall substantially in the ensuing three years, making a significant subtraction from growth in new business investment volumes (Chart A). |
Mining investment is set to pick up markedly in the period ahead, particularly in the gas, coal and metals sectors. Work on a number of large projects is already underway, or about to commence. The competitive Australian dollar, together with higher world prices for some key export commodities (Box 3), has helped boost profitability in the mining industry well beyond previous levels (Chart B). A competitive and profitable mining industry, assisted by an expected world recovery, is driving investment and employment within the sector. Chart B: Mining industry profit and nominal investment
Source: ABS Cat. No. 5676.0 and Treasury. This outlook is supported by the latest ABS capital expenditure survey, where firms indicate growth in mining investment of 25 per cent or more is in prospect in 2002-03. |
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New investment in non-residential buildings and structures is expected to grow by a very strong 14 per cent in 2002-03, following forecast moderate growth of around 6 per cent in 2001-02, and a substantial fall of around 20 per cent in 2000-01. Engineering construction is expected to drive overall growth in non-residential construction in 2002-03. The commencement of engineering construction work on the North West Shelf Expansion and the Alice Springs to Darwin railway increased the level of engineering construction work yet to be done by around $2 billion in the September quarter 2001 (Chart 12). Further project commencements are expected in 2002-03 in the mining industry, including a number of coal and metals projects, and several road projects are also expected to commence in the transport and storage sector.
Chart 12: Work yet to be done - engineering construction
Source: ABS Cat. No. 8762.0.
Investment in new non-residential buildings (that is, offices, shops, hotels and other business premises) is also expected to pick up in 2002-03, albeit with less vigour than engineering construction investment. Growth in non-residential building is likely to be driven by increased building activity in retail, and finance and insurance, given the positive business conditions and strong profitability recently experienced in these sectors.
Investment in intangible fixed assets (that is, computer software, mineral exploration rights and artistic originals) is also expected to pick up in 2002-03, dominated by solid growth in software investment, although at a slower rate than seen in recent years. Software investment is expected to pick up following an easing in growth in 2001-02, after the completion of work relating to the introduction of The New Tax System in 2000, and Y2K-related work in 1999.
While investment intentions data in the mining industry and the transport and storage sector are very strong, investment intentions in some other sectors remain subdued, particularly in parts of the manufacturing industry. If investment intentions strengthen in these sectors over the coming year and current intentions in the mining industry and the transport and storage sector are fully realised, or exceeded, business investment could be stronger than forecast. On the other hand, the lumpy nature of major mining and other engineering construction projects means that potential delays or deferrals pose some downside risks to the forecasts.
Inventories
Private non-farm inventories are expected to subtract around ¼ of a percentage point from growth in 2001-02. In the second half of 2001 it appears that firms attempted to run-down inventory levels, possibly as a result of the global uncertainty following the events of 11 September 2001. This trend is expected to reverse in the first half of 2002, in response to a more certain global outlook.
Private non-farm inventories are expected to contribute around ¼ of a percentage point to GDP growth in 2002-03, as firms continue to rebuild inventories, in line with strong forecast growth in sales.
Public final demand
In 2002-03, public final demand4 is anticipated to grow by around 3¼ per cent in year-average terms, around the longer-term trend and a little below the expected 3½ per cent growth in 2001-02, but well above the 0.5 per cent increase recorded in 2000-01. The expected increase in public final demand reflects additional spending at the Commonwealth, State and Local Government levels. At the Commonwealth level, the expected additional expenditure is linked to the war on terrorism, airport security and border protection. At the State and Local Government levels, the expected increase in expenditure is related to new initiatives on transport, education, health and community services, with a number of infrastructure projects expected to continue into 2002-03.
Net exports and the current account deficit
The current account deficit (CAD) is forecast to widen modestly to around 3¼ per cent of GDP in 2001-02 and to around 4 per cent of GDP in 2002-03. At these levels, the CAD would remain below its average share of GDP during the 1990s, despite strong domestic growth and the recent global slowdown.
Net exports
Net exports are expected to subtract around ¾ of a percentage point from GDP growth in 2001-02, largely reflecting the impact of lower world growth on demand for exports. In 2002-03, net exports are expected to subtract 1 percentage point from GDP growth. While export growth is expected to resume solidly over the course of 2002-03, this is expected to be more than offset by strong import growth.
Export volumes are estimated to decline by 2 per cent in 2001-02, and then grow in 2002-03 by a solid 6 per cent. Even with this rebound, growth will remain slightly below the longer-term trend, reflecting the moderate nature of the recovery in world growth. Export growth in 2002-03 is expected to be underpinned by a rebound in exports of elaborately transformed manufactures (ETMs) and services as demand for these exports increases in response to the moderate pick up in major trading partner (MTP) growth. Exports of non-rural commodities are also expected to record solid growth as domestic capacity increases in 2002-03, while growth in exports of rural commodities should be supported by increases in farm production.
The recovery in world economic growth in 2002-03 - in particular in Australia's MTPs - should have a significant impact on Australia's exports of ETMs and services. These two export categories are very sensitive to economic conditions in the destination country and so have come under considerable downward pressure in 2001-02. Exports of tourism-related services came under additional downward pressure as international air travel declined in response to heightened international tensions arising from the events of 11 September 2001. The recovery in MTP growth, together with the supportive level of the exchange rate, should see ETM and service exports rebound over the course of 2002-03 (Chart 13).
In contrast to ETM and service exports, commodity export volumes tend to be affected more by domestic supply conditions than by international demand in the short term. Following expected modest growth in 2001-02, non-rural commodity exports are forecast to increase solidly over 2002-03 as a number of new mining projects commence production. The strong profitability in Australia's resources sector over recent times, which has been supported by the very high level of Australian dollar non-rural commodity prices, has boosted investment in the capacity of domestic mines. While the timing of the start up of new mining projects can be subject to some uncertainty, a step up in local production, particularly in coal and iron-ore, is expected to support an increase in export volumes from around mid 2002.
Chart 13: Through-the-year growth in ETM
and service exports
and MTP activity
Source: ABS Cat. No. 5302.0 and 1364.0.15.003 and Treasury.
Farm production is expected to grow by around 1¼ per cent in 2001-02, with a near record grain crop partly offset by more subdued production of fibres, particularly wool. In 2002-03, farm production is expected to grow by around 3¾ per cent, reflecting the assumed return to average seasonal conditions. Exports of rural commodities are expected to grow more strongly than farm production in 2002-03 as stocks - particularly wheat and meat - are drawn down to meet demand.
Import volumes have been very subdued over the last two years, with a decline of 1.4 per cent in 2000-01, the lowest growth rate in 10 years. In 2001-02, imports are forecast to turn around, rising by 2 per cent, underpinned by solid growth in most components of merchandise imports, including in several large `lumpy' import components such as military equipment and civil aircraft. In 2002-03, import volumes are expected to grow by a strong 11 per cent, mainly driven by a large expected pick up in the very import-intensive sectors of the economy, particularly in plant and equipment investment and ETM exports, while less import-intensive sectors of the economy, such as dwelling investment, are forecast to moderate (see Box 2).
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Box 2: The drivers of import demand |
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Import volumes fell for the first time since the early 1990s in 2000-01, and are expected to be subdued in 2001-02, before picking up strongly in 2002-03. The profile of activity can only partly explain the profile of imports. For example, the import penetration ratio - the ratio of imports to domestic final demand - fell sharply below trend levels in early 2001 (Chart A). Chart A: Import penetration ratio
Source: ABS Cat. No. 5206.0. The recent weakness in imports partly reflects the significant fall in the Australian dollar which, by increasing the relative price of imports, would |
have led to the substitution of domestically produced for imported goods and services. Another part of the explanation relates to the composition of demand. Import intensity varies between components of demand. For example, plant and equipment investment and ETM exports are import-intensive, while dwelling investment tends to be produced locally (Chart B). While economic growth is expected to be broadly similar in 2001-02 and 2002-03, the composition of growth is expected to change. In 2001-02, economic growth is expected to be largely driven by dwelling investment, while investment in plant and equipment and ETM exports should remain weak. As a result, the composition of demand should see relatively subdued growth in imports. In 2002-03, plant and equipment investment and ETM exports are forecast to pick up strongly, while dwelling investment is expected to fall slightly. As a consequence, relatively strong growth in imports is expected. |
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Chart B: Import intensity by category of final demand
Source: ABS Cat. No. 5209.0 and Treasury. |
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The terms of trade
In currency neutral (Special Drawing Rights (SDR)) terms, Australia's non-rural commodity export prices - as measured by the Reserve Bank of Australia's commodity price index - are expected to increase moderately in 2002-03, following solid growth in 2001-02. The recovery in world growth is expected to underpin increases in the price of many commodities, particularly base metals and mineral fuels. However, while tight supply is expected to support a moderate rise in the negotiated contract price for coking coal, the negotiated contract prices for the other bulk commodities are expected to be more subdued after strong increases in 2000-01.
Following strong growth in 2001-02, aggregate rural prices, in SDR terms, are expected to maintain their current high levels in 2002-03, with increased world agricultural production over the period ahead expected to be broadly matched by the recovery in global demand. Moderately lower export prices for beef and veal are expected to be offset by higher world prices for wool as world production falls against a pick up in consumption in apparel markets. These high prices, combined with the expected rise in farm production in 2002-03, should see farm incomes rise further after reaching well above previous historically high levels in 2001-02 (see Box 3).
Chart 14: Export and import prices in SDR terms
Source: ABS Cat. No. 5302.0 and 5206.0.
Australia's import prices are expected to decline slightly in 2002-03. In SDR terms, Australian import prices have fallen over the last decade at a rate of around 2 per cent per year (Chart 14). A large part of the fall in import prices can be explained by substantial falls of around 16 per cent per annum in the SDR prices of ICT goods. The trend decline of import prices is expected to continue in 2002-03.
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Box 3: Booming conditions in Australia's rural and resource sectors |
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The Australian dollar prices of rural and non-rural commodities have risen very strongly over the past two years to reach record high levels (Chart A). This has reflected higher world prices for many commodities which, together with the lower Australian dollar, has increased the returns on Australian commodity exports. Chart A: Commodity price index
Source: RBA. Australian miners and farmers have reacted to these price rises by increasing production and sales. Between 1999 and 2001 the volume of rural and resource commodity production has increased by 7 per cent and the volume of commodity exports has increased by 10 per cent. Higher prices and production have seen incomes rise to record high levels. Agricultural income has almost doubled over the past two years, while mining profits have almost tripled (Chart B). High levels of production have also stimulated growth in employment in these sectors. In the year to the March |
Quarter 2002, mining employment grew by 10 per cent and agricultural employment grew by 5 per cent. These employment outcomes were markedly stronger than the 1.8 per cent growth for Australia as a whole over this period. Profitable rural and resource conditions have also underpinned strong investment growth. Investment in agricultural machinery picked up by around 30 per cent in the year to the December quarter 2001, while mining investment increased by around 50 per cent over this period. Chart B: Farm and mining income
Source: ABS Cat. No. 5206.0 and 5676.0. Further strong investment growth is expected in these sectors over the coming period, especially in the mining sector (Box 1). Strong investment growth will lead to higher production in Australia's rural and resource sectors, strengthening exports and employment over the forecast period. This will provide further support to rural and regional incomes. |
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Reflecting these forecast trends in export and import prices, the terms of trade is expected to increase by 2¼ per cent in 2001-02, to be around the highest level in a decade. A further increase in the terms of trade of 2¾ per cent is expected in 2002-03 (Chart 15). An increase in Australia's terms of trade during a period of slow global growth is very unusual by historical experience and this issue is discussed in more detail in Budget Statement 4.
Chart 15: Terms of trade
Source: ABS Cat. No. 5206.0 and Treasury.
The current account deficit
The CAD is forecast to widen slightly in 2001-02 to 3¼ per cent of GDP, up from 2.8 per cent of GDP in 2000-01, the lowest annual level in 20 years. The increase in the CAD is expected to be driven mainly by the return to a trade deficit in volume terms, only partially offset by a rise in the terms of trade. In 2002-03, the CAD is expected to widen further, to around 4 per cent of GDP, driven by an increase in the trade deficit in volume terms and a slight increase in the net income deficit (NID), more than offsetting the impact of a further rise in the terms of trade (Chart 16). However, at these forecast levels, the CAD would remain moderate, below its average level as a share of GDP during the 1990s and well below earlier peaks of around 6 per cent of GDP.
Growth in the NID has continued to be modest in recent years, reflecting both the generally low level of world and Australian interest rates, and the sharp narrowing of the differential between Australian and world interest rates. This has seen the NID decline gradually to slightly less than 3 per cent of GDP in 2001-02. With the recent modest increase in world interest rates, the net income balance is expected to widen marginally, increasing to around 3¼ per cent of GDP in 2002-03.
Chart 16: Contributions to the current account deficit
Source: ABS Cat. No. 5302.0 and 5206.0 and Treasury.
Labour Market, Wages and Prices
Labour market
Conditions in the labour market are expected to strengthen over 2002-03, with employment growth forecast to be around 1¾ per cent in both year-average and through-the-year terms. The outlook for strengthening employment growth in 2002-03 reflects ongoing robust GDP growth and continued moderate wages growth. The moderation in the labour market following the completion of Y2K-related expenditure, the Olympics and the development of new systems associated with the introduction of The New Tax System has now run its course. This has seen a rebound in employment in property and business services in the March quarter 2002 (Chart 17), which augurs well for the employment outlook. However, in line with the expected moderation in the labour-intensive construction sector, some softness in labour market outcomes from mid 2002 is expected in the construction sector and the construction-related part of the manufacturing sector.
Chart 17: Employment for selected sectors
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Property and business services |
Construction |
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Manufacturing |
Retail trade |
Source: ABS Cat. No. 6291.0.40.001.
The improved labour market outlook follows likely employment growth of around 1 per cent in 2001-02. The lagged effects of the recent strong GDP growth began to flow into employment growth toward the end of 2001 and early 2002. Total employment grew by 1.1 per cent in the year to April 2002. This growth was concentrated in part-time employment, which grew by 4.9 per cent over this period, while full-time employment fell slightly. The strong growth in part-time employment reflected, in part, strong growth in those industries that typically employ a relatively large proportion of part-time employees, in particular retail and the other service sectors.
The major job advertisement series, vacancy series and business surveys all point to employment growth continuing at a solid rate in the months ahead, with higher employment growth anticipated across a range of sectors. Nevertheless, labour market data have been particularly volatile over the last year or so, making it difficult to assess the strength of the labour market.
In line with this improved outlook for employment, the unemployment rate (Chart 18) is expected to decline slightly over the forecast period, and to average around 6¼ per cent in 2002-03 as a whole and to be 6 per cent in the June quarter of 2003. However, monthly labour market data may vary significantly around these averages. Provided that economic growth remains robust, an unemployment rate below 6 per cent is achievable over the medium term, although outcomes will be influenced by the pace and extent of future labour market and welfare reforms. Ongoing employment growth and further reductions in the unemployment rate are likely to encourage higher labour force participation over the period ahead, with the participation rate expected to average around 63¾ per cent over the forecast period, up from 63.4 per cent in April 2002. However, given the volatility in estimates of labour force participation over recent months, some uncertainty remains around this forecast and hence the forecast for the unemployment rate.
Chart 18: The unemployment rate
Source: ABS Cat. No. 6202.0 and Treasury
After reaching a cyclical low in 2000-01, labour productivity growth (on a heads basis) is set to rebound strongly in 2001-02, before moderating to rise by around 1¾ per cent in 2002-03, in line with longer run average growth rates. Measured labour productivity growth in 2002-03 is expected to be supported by the forecast very strong growth in business investment, which will tend to lift the potential output of the existing labour force.
Wages
Wages growth in 2001-02 has been very moderate to date, consistent with the relatively soft labour market conditions experienced during 2001. A sharp decline over the course of 2001 in average weekly hours worked also put downward pressure on aggregate wages during this period (Chart 19).
Chart 19: Average weekly hours worked
Source: ABS Cat. No. 1364.0.15.003.
Average earnings on a national accounts basis (AENA) is expected to grow by 3¼ per cent in 2001-02, with growth in the second half of the financial year picking up as labour market conditions improve and as the decline in average weekly hours worked over the course of 2001 is unwound in 2002.
Growth in AENA is expected to increase to 4¼ per cent in 2002-03. Abstracting from the increase in the superannuation guarantee charge on 1 July 2002, AENA is expected to grow by 3¾ per cent in 2002-03. This increase in wages growth reflects the improvement in employment growth and unemployment levels and an expected increase in average weekly hours worked to around trend levels. The Australian Industrial Relation Commission's (AIRC) Safety Net Review of Wages (the `Living Wage Case') decision to increase all award rates by $18 per week will also put upward pressure on wages growth.
The pace of the pick up in economic activity and the timing of its impact on the labour market represents a key uncertainty to the wages outlook. In addition, the extent to which the AIRC's decision flows through to workers on non-award wages could also represent a further pressure on wages growth.
Prices
In 2001-02, the CPI is expected to increase by around 2¾ per cent in year-average terms. However, several temporary and seasonal factors have played an important role in the CPI outcomes for the year to date. On the upside these include: a large increase in fruit and vegetable prices in the December quarter 2001 (up 10.2 per cent); and seasonal influences in the March quarter 2002 relating to a number of items including pharmaceuticals (up 11.4 per cent) and education (up 4.7 per cent). In addition, airline levies arising from the collapse of Ansett and the events of 11 September 2001 have also had an upward impact on the CPI. Insurance premiums have also risen, partly attributable to the collapse of HIH. Partly offsetting these increases was a large decline in the price of petrol in the September quarter 2001 (down 8.3 per cent).
Looking ahead, a range of near term upward price pressures are evident, such as higher petrol prices and insurance premiums. One insurance component not directly captured by the CPI is business insurance - the magnitude and timing of these increases and their indirect effect on the CPI is uncertain. Nevertheless, increases in wage costs remain well contained. In addition, various core measures of inflation showed a more moderate increase in the March quarter 2002 than over recent quarters, and recent measures of upstream price pressures have also been very subdued.
The headline CPI is forecast to increase by around 2¾ per cent in 2002-03 in year-average terms and around 2½ per cent through the year, within the medium-term target band of 2-3 per cent. Although economic growth is forecast to be robust in both 2001-02 and 2002-03, this follows very subdued growth of 1.9 per cent in 2000-01, with some build up in excess capacity in the economy at that time most evident in a rising unemployment rate. The robust growth forecast in 2001-02 and 2002-03 will allow this spare capacity to be taken up gradually, rather than necessarily resulting in a build up of inflationary pressures. This seems to be consistent with the current relatively moderate underlying inflationary pressures in the economy. Labour productivity, which grew by a strong 2.3 per cent in year-average terms in 2001 (on an hours basis), is expected to increase solidly over the forecast period. Moderate wages growth, combined with solid expected increases in productivity, should see nominal unit labour cost increases - the key driver of inflation over the medium term - remain subdued. In addition, import prices should be subdued as world prices are expected to remain steady, and the exchange rate has appreciated somewhat over recent months - both of these factors should assist to ease inflationary pressures.
There are some key uncertainties surrounding the inflation outlook. The ongoing effect of reduced competition in some markets, particularly in air travel and insurance, is difficult to quantify. The stronger economic environment could also create an opportunity to re-build margins following the decline in the exchange rate over the last two years. Should this occur, and/or other short-term price pressures feed into inflationary expectations (and then wages), it could have an impact on underlying inflationary pressures. The extent to which the recent strong rise in world oil prices is sustained and leads to higher petrol prices is also a risk to the inflation outlook.
2 See Economic Roundup Summer 2002, Australian Net Private Wealth, Department of Treasury, Canberra; and Tan, Alvin and Voss, Graham, 2000, `Consumption and Wealth', Reserve Bank of Australia Research Discussion Paper 2000-09.
3 Private sector net purchases of second-hand public assets can have a significant impact on estimates of business investment and public final demand, despite the fact that these asset purchases have no impact on aggregate economic activity. Accordingly, the forecasts of new business investment abstract from these transactions.
4 The forecasts of public final demand abstract from private sector net purchases of second-hand public sector assets - see footnote 3.
