Domestic forecasts
The forecasts for the domestic economy are underpinned by several technical assumptions. The exchange rate is assumed to remain around the average level of recent months (a trade weighted index of around 64 and a $US exchange rate of around 74c). Interest rates are assumed to remain unchanged at current levels. World oil prices (West Texas Intermediate) are assumed to remain around $US60 per barrel until June 2007, in line with current market expectations. The farm sector forecasts are based on an assumption of average seasonal conditions in 2006-07.
The Australian economy is forecast to grow by 3 per cent in both 2005-06 and 2006-07. The key domestic economic forecasts are summarised in Table 4.
Table 4: Domestic economy forecasts(a)
- Percentage change on preceding year unless otherwise indicated.
- Calculated using original data. Outcomes have been calculated using September 2005 Quarterly National Accounts, where possible.
- Chain volume measure.
- Excluding transfers of second-hand asset sales from the public sector to the private sector.
- Percentage point contribution to growth in GDP.
- For presentational purposes, forecast changes in inventories held by privatised marketing authorities are included with the inventories of the farm sector and public marketing authorities.
Source: Australian Bureau of Statistics (ABS) Cat. No. 5206.0, 5302.0, 6202.0, 6401.0, unpublished ABS data and Treasury.
Household consumption is forecast to grow by 2¾ per cent in both 2005-06 and 2006-07, significantly slower than the 4.3 per cent growth recorded in 2004-05. A slowing in household consumption was evident through the year to the September quarter 2005, suggesting that the combined impact of lower growth in housing wealth, higher debt servicing ratios and higher petrol prices are affecting households’ consumption decisions. Despite the anticipated consolidation of household finances over the next two years, continuing high house prices are likely to result in further increases in household debt-to-income levels.
Petrol prices increased from an average of around $0.60 per litre in early 1999 to close to $1.00 per litre in late 2000 and remained around that level until early 2005. The increase in oil prices in 2005, however, has seen petrol prices move significantly higher, to average between $1.20 and $1.30 per litre in recent months. Following this increase, there has been some evidence of increased usage of public transport and a shift to purchases of more fuel efficient vehicles by some households, but it is difficult for households to reduce their consumption of petrol in the short run. Therefore, higher petrol prices are expected to remain a significant factor for household budgets through 2005-06, reducing the scope for faster growth in the volume of consumption.
Very strong employment growth has supported household incomes over the past year, partly offsetting the negative impact of higher petrol prices. Employment growth is expected to slow through 2005-06 in response to relatively slow GDP growth through 2004-05, but household incomes will continue to benefit from the tax cuts and increases to family assistance announced in the 2005-06 Budget.
Dwelling investment plateaued through 2004-05, after strong growth in earlier years. Dwelling investment is expected to be flat in 2005-06. The current housing construction cycle has been very moderate compared with past cycles, in part reflecting the stability of the broader macroeconomic environment. The sharp run-up in established house prices experienced in the first half of this decade has come to an end and the adjustment process to date has been very orderly. The forecasts assume that established house prices remain flat on average as this adjustment process continues.
The investor segment of the housing market, in particular, has been affected by the slowdown in house price growth. By mid-2005, finance for investor housing had fallen to a little above $5 billion per month, well below its peak of $7.7 billion in October 2003. Finance for owner occupied housing, in contrast, has surpassed its 2003 peak, and first home buyers are moving back into the housing market in larger numbers. These trends are expected to continue into 2005-06.
Business investment is expected to grow by 11 per cent in 2005-06 and 7 per cent in 2006-07. Growth in both non-dwelling construction and machinery and equipment investment is expected to be strong through the forecast period.
As outlined at Budget, strong world demand for commodities is spurring investment in the mining industry. This has led to substantial activity on mining production facilities and associated infrastructure, particularly in Western Australia. With commodity prices expected to remain high for some time yet, the incentive to invest remains strong. The Australian Bureau of Statistics’ most recent CAPEX survey estimate of mining investment intentions for 2005-06 was 23.4 per cent higher in nominal terms than the equivalent estimate for 2004-05. The CAPEX survey also pointed to strong investment intentions for other industries in 2005-06, with expectations for the manufacturing and other selected industries categories also increasing by around 16 per cent on the equivalent 2004-05 estimates. These increases would build on the widespread increase in business investment seen since early 2002.
Public final demand is forecast to grow by 3 per cent in 2005-06 and 2¾ per cent in 2006-07. Continuing solid public investment spending is expected to support growth in 2005-06 and 2006-07.
Net exports are expected to subtract ¾ of a percentage point from GDP growth in 2005-06 and ½ of a percentage point in 2006-07. Export growth is forecast to increase in 2005-06, with the largest contribution coming from non-rural commodity exports. Import growth is expected to ease in 2005-06 and 2006-07 as gross national expenditure slows.
Exports are forecast to increase by 4 per cent in 2005-06 and 6 per cent in 2006-07. Rural exports are expected to fall in 2005-06, before increasing in 2006-07, while the other categories of exports are expected to grow solidly in both years.
Disappointing winter crops in 2004 led to a fall in rural export volumes that will be felt into 2005-06. While dry weather conditions earlier in 2005 saw a smaller area planted for winter crops than would normally be the case, good spring weather conditions have resulted in higher yields. Improved weather conditions this spring will also assist with rebuilding livestock numbers after the drier conditions of recent years.
Non-rural commodity exports are expected to grow strongly over the next two years reflecting significantly increased capacity in the mining sector. However, since Budget, forecast growth for non-rural commodity exports has been revised down. This partly reflects lower than expected growth in oil production. Exports fell in the September quarter 2005, reflecting delays to the export of some liquefied natural gas and iron ore from Western Australia and the closure of the Hay Point coal terminal in Queensland for upgrade work. These factors are expected to be temporary and, as they recede, export growth is expected to lift significantly in coming quarters.
Exports of elaborately transformed manufactures (ETMs) are forecast to grow solidly over the next two years, supported by continuing strong world growth. Two factors are, nevertheless, likely to continue to constrain ETM export growth over the period ahead. Australian manufacturers are facing increased competition from manufacturers in industrialising countries and high commodity prices may also be contributing to the exchange rate remaining higher than would otherwise be the case.
Service exports are expected to grow only slowly over the next two years. As for ETM exports, strong world demand will support service exports, partly offset by the effects of the exchange rate. Exports of tourism services are also likely to be constrained by continuing global health and security concerns.
Imports are forecast to grow by 7 per cent in 2005-06, before slowing to 6 per cent in 2006-07. The forecast for import growth reflects the expected slowing in gross national expenditure. Falling prices for a range of imported consumer and capital goods, particularly those with a high technology component, should support growth in those categories of imports.
The terms of trade are expected to increase by 9½ per cent in 2005-06 before falling by ½ per cent in 2006-07. The expected increase in 2005-06 largely reflects movements in contract prices for Australia’s coal and iron ore exports. The expected increase, if realised, will take the terms of trade to around 30-year highs.
New contracts negotiated in early 2005 were for an increase in iron ore prices of around 70 per cent and an increase in metallurgical coal prices of around 120 per cent. These increases have already begun to affect the terms of trade and will continue to do so into 2006 as existing contracts are fulfilled and rolled over. Iron ore and coal prices are expected to stabilise in the next round of contract negotiations, although there is considerable uncertainty around this forecast.
The current account deficit (CAD) is expected to narrow to around 5½ per cent of GDP in 2005-06. Increasing commodity prices are contributing to an improvement in the trade deficit, but this is being partially offset by an increase in the net income deficit as the ownership of part of the additional profits accrues overseas.
Employment growth was very strong in 2004-05, supported by high levels of activity in the construction and mining sectors of the economy. Employment is expected to slow to 2 per cent in 2005-06 and 1 per cent in 2006-07 in response to the lower GDP growth experienced through 2004-05. This would imply a cyclical rebound in productivity growth.
The unemployment rate is anticipated to remain around 5¼ per cent in 2005-06, slightly above the Budget forecast. In 2006-07, the unemployment rate is expected to stay at 5¼ per cent.
Wage growth is expected to increase in 2005-06 following strong growth in employment, before moderating in 2006-07 as employment growth eases. The Wage Price Index is forecast to grow by 4¼ per cent in 2005-06 and 4 per cent in 2006-07. Tight labour market conditions in some sectors, such as mining and construction, have led to substantial relative wage movements. However, these pressures are not expected to spill over into significant generalised wage increases.
Inflation is forecast to increase to 3 per cent in 2005-06, before falling back to 2½ per cent in 2006-07. The forecast rise in inflation in 2005-06 largely reflects higher oil prices, with petrol prices expected to add around ½ of a percentage point to inflation through the year to the June quarter 2006. While the increase in petrol prices has led to some increases in other prices, particularly in the transport sector, the overall impact is expected to remain contained.
The cyclical slowing in labour productivity over the past year has contributed to an acceleration of unit labour costs. However, as noted, with employment growth slowing through 2005-06 and 2006-07, labour productivity growth is expected to strengthen. This will cause growth in unit labour costs to moderate through 2006-07, reducing the pressure on inflation from labour costs.