International economic outlook
At Budget, the world economy was slowing from the exceptional pace recorded in 2004. The return to a more sustainable, but still robust, growth path in 2005 reflects the unwinding of expansionary monetary and fiscal policies across a wide group of economies and higher oil prices. In 2006, barring major unforeseen events, monetary policy in the United States should be less accommodative than in 2005 and oil prices are likely to remain at high levels (although below the peaks reached in late August 2005). The global economic outlook remains positive, given the expected continuation of robust growth in the US, the strong performance of the Chinese and Indian economies, and the recovery in Japan.
The August and September hurricanes in the Gulf of Mexico caused major disruptions to already tight global energy markets. However the world economy appears to have weathered the impacts of this disruption, and growth remains on track. This resilience is testament to the strength of the underlying fundamentals supporting the global economy, particularly benign financial conditions and the healthy corporate balance sheets in the major regions. Some inflationary pressures are emerging, but inflation expectations remain reasonably well contained.
The world growth forecast for 2005 has been revised to 4½ per cent, ¼ of a percentage point higher than at Budget, while the 2006 forecast has been revised to 4½ per cent, ½ of a percentage point higher than at Budget (Table 3). Major trading partner (MTP) growth is expected to be 4¼ per cent in 2005 and 2006, an upward revision from Budget of ½ of a percentage point in each year. These upward revisions are due largely to higher expected growth in China, Japan and India.
Table 3: International GDP growth forecasts(a)(b)
- Percentage change from preceding year.
- Growth rates for the World and euro area are calculated using GDP weights based on purchasing power parity, while growth rates for Major Trading Partners and other East Asia are calculated using export trade weights.
- Other East Asia comprises Korea, Singapore, Taiwan, Hong Kong, Indonesia, Malaysia, Thailand, and the Philippines.
Source: National statistical publications, IMF and Treasury.
The economic expansion in the United States has matured, and growth is expected to remain around recent trend rates. US growth is forecast to be 3¾ per cent in 2005 and 3½ per cent in 2006.
To date, domestic demand has shown a high degree of resilience to tightening policy and adverse economic shocks, and is likely to remain the key driver of growth. Conditions for business investment remain positive, with corporate profits around record levels and external financing conditions still favourable. Against this background, the labour market is expected to continue to firm at a steady pace. Combined with recent increases in house prices, this should provide support for household consumption as the effects of higher interest rates and energy prices take hold.
Headline inflation has spiked in recent months reflecting the effects of higher petrol prices, although, to date, underlying measures of inflation remain contained. A key risk remains that higher energy prices could result in more generalised inflationary pressure, particularly as excess capacity in the economy is reduced.
In Japan, economic activity has picked up since budget, with GDP growing by 2.9 per cent through the year to the September quarter 2005. GDP growth to date in 2005 has been relatively balanced, with contributions from nearly all sectors of the economy. This growth pattern is encouraging for a sustainable economic recovery. The deflation that has plagued the economy for over five years is waning and the decade long decline in asset prices appears to have bottomed out.
Growth in the Chinese economy has been stronger than anticipated, with GDP expanding by 9.4 per cent through the year to the September quarter 2005. Recent signs suggest that this growth is being underpinned by a recovery in domestic demand, following a slowdown engineered by the Chinese authorities in response to the investment boom in 2004. A shift in investment from overheated sectors to those experiencing bottlenecks suggests that current levels of investment may be less worrisome than in the past, particularly as this investment is being led by the private sector rather than state-owned enterprises. While expectations remain for a gradual deceleration in growth, the timing of the slowdown has been pushed out.
In the rest of East Asia, economic activity moderated in the first half of 2005, reflecting higher oil prices, weaker Chinese imports, and slower world demand for information and communication technology (ICT) products. High oil and commodity prices and the reduction of oil subsidies generated inflationary pressures in some East Asian economies, prompting central banks to tighten monetary policy. The outlook is for growth to pickup in 2006, supported by an upturn in the world ICT cycle and solid domestic demand, particularly in Korea. However, high and volatile oil prices remain a significant risk to East Asia, due to the region’s heavy dependence on oil imports and because oil costs form a relatively large part of these economies’ expenditure baskets.
Expectations for euro area GDP growth in 2005 have remained on track since Budget, but the 2006 forecast has been revised down by ¼ of a percentage point to 1¾ per cent. GDP grew by 0.6 per cent in the September quarter 2005 to be 1.6 per cent higher through the year. This growth was supported by accommodative monetary conditions, a pick-up in business investment, and a positive contribution from net exports. The recovery remains fragile however, as consumption and household sentiment indicators remain weak, partly due to high oil prices. Headline inflation in the euro area is around 2½ per cent and the European Central Bank raised official interest rates in December 2005 to 2¼ per cent, noting that monetary conditions are still accommodative. The euro area unemployment rate has steadily declined in 2005 to be 8.3 per cent in October.
In the United Kingdom, growth has moderated from the strong pace recorded in 2004. GDP increased by 0.4 per cent in the September quarter, to be 1.6 per cent higher through the year. Consumption growth fell away markedly in the first half of 2005, reflecting the lagged effects of past interest rate increases, sharp reductions in house price growth and some easing in the labour market. Recent indicators suggest that growth is expected to pick up in 2006 and 2007.
The risks to the near term world economic outlook are broadly balanced. A positive development is the broadening of world growth, with the strengthening of the Japanese economy and an expected improvement in activity in the euro area. Though oil prices have moderated somewhat from the highs experienced in August and September following the hurricanes in the Gulf of Mexico, they remain high and volatile. A sustained period of high oil prices could adversely affect world growth. To date, the inflationary effects of high oil prices have been limited, with significant second round effects yet to be seen in most major economies and regions.
There remains the potential for a disorderly adjustment of global saving and investment imbalances. Such an outcome could affect exchange rates and global growth. Since Budget, global imbalances have continued to widen, with the US current account deficit now at a record 6.4 per cent of GDP. In oil exporting nations, such as Saudi Arabia, higher oil prices have led to considerable increases in public saving.
That said, several factors are supporting the global expansion, particularly accommodative monetary policy, generally benign global financial market conditions, and strong corporate balance sheets in the major regions.