Domestic and international economic outlook
The Australian economy is expected to grow by 2½ per cent in 2006-07, significantly slower than the Budget forecast of 3¼ per cent. The downward revision to GDP growth largely reflects the severe drought being experienced across large parts of Australia. Farm GDP is now expected to fall by around 20 per cent in 2006‑07, down from the 2 per cent increase anticipated at Budget. In 2007-08, GDP growth is forecast to accelerate to 3¾ per cent. Non-farm GDP is expected to grow by 3 per cent in 2006-07 and 3¼ per cent in 2007-08, while the farm sector is assumed to recover on the basis of a return to average seasonal conditions.
The outlook for the world economy remains positive, and is broadly unchanged from Budget. World GDP growth is expected to be 5¼ per cent in 2006, ¼ of a percentage point stronger than at Budget, before easing to 4¾ per cent in 2007. Ongoing above-average world growth is supporting a substantial increase in commodity prices, which is boosting Australian production and income growth.
The composition of Australian economic growth is expected to shift from business investment to exports through 2006-07 and 2007-08. Following four years of very strong outcomes, business investment growth is expected to ease. The high level of investment and the resultant boost to resource sector productive capacity should support stronger non-rural commodity exports. Consumption growth is expected to remain moderate as the household sector continues to consolidate its financial position. This consolidation is being supported by solid income growth and further increases in net wealth. Dwelling investment is expected to undergo a modest recovery, after a mild slowdown.
Employment growth has been stronger than anticipated at Budget, contributing to the unemployment rate falling to 30-year lows. However, employment growth is expected to moderate in the period ahead, in line with around trend non-farm output growth. The easing in labour market conditions should see wage growth remain moderate.
Mostly reflecting sharp increases in fuel and fruit prices, inflation has been higher than anticipated at Budget. As these sharp increases unwind, inflation is expected to fall temporarily below 2 per cent in 2007. Underlying inflationary pressures are expected to ease gradually over the forecast period, with inflation settling in the middle of the target band by 2008.
The risks to the domestic economy are weighted to the downside, particularly if dry conditions persist and seasonal conditions do not return to average in 2007-08 as assumed. In addition, given the high level of household debt there remain downside risks around the speed and extent of the household sector's response to the recent tightening of monetary policy.
Prices for non-rural commodities are difficult to predict and if they were to remain high or increase further this would provide an additional boost to domestic income. However, there is a risk that if capital and labour do not move to the fast-growing sectors of the economy in response to the surge in commodity prices, output growth could be constrained and there may be further significant upward pressure on prices.
Table 2 presents the major economic parameters used in preparing the Mid-Year Economic and Fiscal Outlook 2006-07. The parameters for 2006-07 and 2007-08 are forecasts while those for 2008-09 and 2009-10 are projections. The projections of economic growth are based on analysis of underlying trends in employment and productivity. The projection assumption for productivity has been adjusted to reflect Australia's long-run average productivity growth rate of 1¾ per cent. As at Budget, key commodity prices are assumed to return to their long-run average level over the two projection years. This is broadly consistent with aggregate non-rural commodity prices retracing almost 60 per cent of their recent gain by the end of the projection period. For a discussion of this technical assumption see the 2006-07 Budget. The projections of inflation are consistent with the medium-term inflation target band.
Table 2: Major economic parameters(a)
- Year-average percentage change.