Part 2: Economic outlook
The Australian economy is expected to grow solidly in 2005-06 and 2006-07, with GDP forecast to increase by 3 per cent in both years. The forecast for GDP growth in 2005-06 is unchanged from that presented in the 2005-06 Budget. An acceleration of exports is expected to support economic growth, while growth in household consumption and dwelling investment is expected to be relatively subdued. This gradual rebalancing of growth from domestic to external sources is desirable and will underpin the sustainability of the current economic expansion. A major change to the economic environment since the Budget has been a further increase in oil prices. As the effects of these higher oil prices flow through the economy, inflation is expected to rise to 3 per cent in 2005-06, before easing back to 2½ per cent in 2006-07.
Prospects for world economic growth remain favourable. World GDP is forecast to grow by 4½ per cent in 2005, ¼ of a percentage point higher than at Budget. In 2006, world GDP is forecast to grow by 4½ per cent, up from the 4 per cent forecast in the 2005-06 Budget. The revised forecasts reflect an improved outlook for the economies of China, Japan and India. Strong growth in the world economy is contributing to higher prices for some commodities, notably oil, coal and iron ore.
The effects of high commodity prices on the Australian economy have been significant. Australia’s real purchasing power increased strongly in 2004-05, with real gross domestic income increasing by 4.1 per cent, well above the GDP growth rate of 2.4 per cent. Gross domestic income is also forecast to increase faster than GDP in 2005-06, as the effect of higher coal and iron ore prices flows through to export income. As additional supply of coal and iron ore reaches world markets, their prices are forecast to stabilise in 2006, but still remain well above the prices that prevailed before 2004.
The strong growth in incomes has been supporting domestic spending, with gross national expenditure expanding by 4.1 per cent in 2004-05. Gross national expenditure is forecast to slow to 3½ per cent in 2005-06 and 3¼ per cent in 2006-07, mainly reflecting slower forecast growth for household consumption.
Household consumption grew quickly in 2004-05. In recent quarters, higher petrol prices and slower growth in housing wealth have constrained household spending and consumption growth in 2005-06 is expected to be lower than in 2004-05. However, consumption will continue to be supported by strong employment and 2005-06 Budget measures that provide tax cuts and increased support for families.
Business investment is expected to remain solid in both 2005-06 and 2006-07 as businesses take advantage of strong balance sheets to fund increases in productive capacity. The latest expectations data from the Australian Bureau of Statistics indicate that business investment growth should be broadly based across industries. Investment in the mining sector will continue to be spurred by high commodity prices.
Strong world demand is expected to support solid export growth in 2005-06 and 2006-07. An expansion of output in the mining sector will contribute to higher growth in non-rural commodity exports. High commodity prices are likely to continue to support the exchange rate, which will constrain growth in manufactured and service exports, as will strong competition from newly industrialising countries. World tourism continues to be affected by security and health-related concerns.
Employment growth was very strong through 2004-05, leading to a fall in the unemployment rate to 28-year lows. Employment growth is forecast to slow through 2005-06 and 2006-07 in response to slower GDP growth through late 2004 and early 2005. Easing employment growth should see the unemployment rate stabilise near current levels.
Aggregate wage growth has increased reflecting tighter labour market conditions over the past year. Wage growth is expected to peak in 2005-06, before slowing in 2006-07. The increase in wage growth has been concentrated in those sectors experiencing strong demand, such as construction and mining, with a smaller pass-through to wage outcomes in other sectors than would have been the case in the past. This enhanced relative wage flexibility is a benefit of Australia’s more efficient labour market and reduces the propensity of higher wage outcomes in some sectors to flow through to higher consumer prices.
Higher petrol prices are forecast to contribute ½ of a percentage point to inflation through the year to the June quarter 2006. As a result, headline inflation is expected to be 3 per cent in 2005-06, before falling back to 2½ per cent in 2006-07. Inflation expectations remain well-anchored and the second-round effects from higher petrol prices are expected to be modest.