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 77c). Interest rates are assumed to remain unchanged at their current levels. World oil prices (West Texas Intermediate) are assumed to be around $US65 per barrel on average, in line with current market expectations. The farm sector forecasts are based on an assumed return to average seasonal conditions in 2007-08.
The Australian economy is forecast to grow by 2½ per cent in 2006-07 and 3¾ per cent in 2007-08. 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.
- Chain volume measure.
- Excludes second-hand asset sales from the public sector to the private sector.
- Percentage point contribution to growth in GDP.
- For presentation purposes, 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 No. 5206.0, 5302.0, 6202.0, 6345.0, 6401.0, unpublished ABS data and Treasury.
Household consumption is expected to grow by 3 per cent in 2006-07 and 3¼ per cent in 2007-08, slightly faster than the 2.6 per cent growth recorded in 2005-06. As at Budget, consumption growth is expected to remain a little below trend, reflecting ongoing consolidation in household balance sheets. Consumption growth is being supported by solid increases in household incomes reflecting strong employment growth, personal income tax cuts and more recently lower petrol prices. Household net wealth is expected to grow modestly, in part reflecting a return to moderate house price growth which will also support consumption. These factors are being partially offset by an increased household debt-servicing burden given the recent increases in interest rates.
Dwelling investment is expected to grow modestly in both 2006-07 and 2007-08, following mild declines in the preceding two years. Solid dwelling investment growth since Budget and the recent firm dwelling approval outcomes signal a modest recovery in the housing market. The recovery in dwelling investment is expected to be led by alterations and additions and purchases by owner-occupiers, as the recent interest rate increases and low rental yields are expected to continue discouraging investors.
Business investment growth is expected to slow significantly to 1 per cent in 2006-07 and remain moderate in 2007-08. This is weaker than expected at Budget and follows four years of robust growth. The Australian Bureau of Statistics' September 2006 Survey of New Capital Expenditure and Expected Expenditure (CAPEX) indicates that investment intentions for 2006-07 are weak across most industries. However, the investment environment remains favourable, particularly for the mining sector and new buildings and structures investment, with the cost of capital remaining low, corporate finances healthy and capacity utilisation around record highs.
Public final demand is expected to ease to 3¼ per cent in 2006-07. This follows two years of strong public investment growth at both the Commonwealth and State and Local levels.
Net exports are expected to subtract significantly less from GDP growth over the forecast period than they have in recent years, largely due to expected strong growth in non-rural commodity exports and moderate growth in imports.
Exports are expected to increase by 4 per cent in 2006-07 and by 6 per cent in 2007-08. The weaker outlook for export growth compared with Budget reflects a weaker outlook for rural and elaborately transformed manufactures (ETM) exports. The effect of weaker farm production on rural exports is expected to be partially offset by a run-down in grain inventories from their current high levels. Non-rural commodities exports are expected to grow strongly in 2006-07 and 2007-08, as production from newly completed projects increases. ETM and service exports are expected to record only modest growth in 2006‑07, reflecting continued international competitive pressures and sustained higher air travel costs to Australia.
Imports growth is expected to remain around 5 per cent in 2006-07 and 6 per cent in 2007-08, reflecting solid growth in gross national expenditure.
The terms of trade have increased to their highest level since the early 1950s. This outcome is higher than expected at Budget, reflecting higher non-rural commodity prices. The terms of trade is expected to fall in 2007-08, reflecting falls in non-rural commodity prices and modest increases in import prices. Recent high commodity prices have encouraged substantial investment in mining capacity, both in Australia and around the world. As this increased capacity comes on line, it is expected to lead to a decline in commodity prices.
The current account deficit (CAD) is expected to narrow in 2006-07, in contrast to an expected widening at Budget. The higher terms of trade and slower import growth have contributed to the improved outlook for the CAD. High domestic profits combined with an increase in world interest rates and a higher stock of net foreign debt are expected to contribute to a widening of the net income deficit in 2006-07. As commodity prices partially unwind, the CAD is expected to widen modestly in 2007-08.
Recent employment outcomes have been substantially stronger than anticipated at Budget, with the unemployment rate falling to 4.6 per cent, a 30-year low. Employment is expected to increase by 2¼ per cent in 2006-07, before moderating to 1¼ per cent in 2007-08. The unemployment rate is expected to be around 5 per cent in 2006-07, lower than the Budget forecast of 5¼ per cent.
The participation rate has been higher than anticipated and is expected to rise further in 2007-08, largely reflecting the Government's Welfare to Work reforms. Participation requirements for Disability Support Pension and Parenting Payment recipients should lead to more people entering the labour force, boosting Australia's productive capacity. The unemployment rate is expected to increase in 2007-08 as the people entering the labour market as part of the Welfare to Work reforms take time to gain employment.
Wage growth is expected to remain contained. The Wage Price Index is expected to grow by 4 per cent in 2006-07 and 2007-08. Recently growth has moderated, although this in part reflects a change in the timing of award wage increases announced by the Fair Pay Commission. While wage growth has been strong in some sectors, particularly in mining and construction and to a lesser extent the public sector, these sector-specific pressures are not expected to spill over to more rapid aggregate wage increases.
Inflation has been higher than expected at Budget, largely reflecting the jump in petrol prices in mid-2006 and the one-off impact of Tropical Cyclone Larry on fruit prices, although underlying inflationary pressures have also been present. As petrol and fruit prices unwind in 2007, inflation is expected to fall temporarily below 2 per cent. The indirect effects of higher fuel prices and solid unit labour cost growth have also contributed to recent inflationary pressures. With petrol prices now below recent highs and productivity growth expected to strengthen, these underlying inflationary pressures are expected to moderate, resulting in inflation returning to around the middle of the target band by 2008.
Box 1: Drought Severe drought conditions have affected large areas of Australia during 2006. As a result, farm production is forecast to fall by around 20 per cent in 2006-07. The drought is expected to subtract ¾ of a percentage point from GDP growth in 2006-07, reflecting its impact on the farm sector and related industries, such as transport and storage. The expected fall in farm production is close to that experienced in the 2002-03 drought (Chart A). The effect of the drought on rural exports is expected to be reduced slightly by running down the current high level of grain stocks. Nevertheless, rural exports are forecast to fall by 7 per cent in 2006-07. Chart A: Farm production and rural exports
Source: ABS cat. no. 5302.0, 5206.0 and Treasury. |
The impact of the drought is expected to be more pronounced across southern Australia. Rainfall deficiencies during the winter cropping season were particularly bad in Western Australia's grain belt and across much of New South Wales, Victoria and South Australia. Farm incomes are expected to be severely affected by the drought. Lower farm incomes are likely to lead to lower consumption, investment and employment in rural communities. To some degree this will be mitigated by the Farm Management Deposits scheme, which allows farmers to draw down savings, and by Exceptional Circumstances assistance. Higher grain and fruit and vegetable prices will flow through to retail prices. However, in the short term, retail meat prices are likely to moderate in response to increased livestock slaughter rates. Overall, the net effect on inflation is expected to be relatively small. |
