As identified at Budget, the path of commodity prices remains an important risk for the Australian economy. The timing and extent of the expected increase in the world supply of commodities and the likely reversion of prices to more normal levels is uncertain. In the forecast period, aggregate non-rural commodity prices are expected to stabilise and remain at very high levels compared with the experience of recent years. Beyond the forecast period, a broader fall in non-rural commodity prices is incorporated into the projections — this follows the methodology adopted in the 2005-06 Budget.
Oil prices are assumed to remain high over the forecast period, in line with expectations from the futures market. Nevertheless, conditions in the oil market are volatile, making the future path of oil prices uncertain. Were oil prices to increase above their current levels, it is likely that consumption growth would slow by more than expected. However, to the extent that any increase was reflected in the prices of other energy products such as coal and liquefied natural gas, Australia may benefit through a higher terms of trade.
Strengthening wage growth has been largely confined to particular industries and geographic regions that have been experiencing strong growth. To date, strong wage growth in some sectors has not spilled over into more generalised wage pressures. However, the risk that higher wage demands may flow to other sectors remains, particularly as higher petrol prices push headline inflation temporarily higher. Were higher wage demands to be met without offsetting productivity increases, then this would present an upside risk to the inflation forecasts.
House prices have begun to adjust following the run-up experienced through the first half of this decade. Prices have plateaued in most capital cities over the past year, and fallen in some. This steady adjustment path is expected to continue over the next few years. Nevertheless, there remains a risk that a shock to the economy could induce a sharper adjustment in house prices, with negative implications for consumption and dwelling investment. Even without a large fall in house prices, there is still a possibility that consumption is weaker than expected, with households choosing to consolidate their balance sheets more rapidly.
Forecasts for world growth have been revised up since Budget, with some earlier risks affecting the near term outlook ameliorating somewhat. Nevertheless, some negative risks remain. In particular, while oil prices have moderated from spikes in August and September they remain relatively high and volatile. A sustained period of high oil prices could adversely affect global growth. In addition, there remains the potential for a disorderly adjustment of global saving and investment imbalances. Such an outcome could have substantial impacts on exchange rates and global growth. Notwithstanding these downside risks, several factors continue to support the global expansion. Monetary policy is still, on balance, accommodative; corporate balance sheets are strong; and financial market conditions are generally benign across most regions.