Australian Government, 2007–08 Budget

Statement 3: Economic Outlook

The Australian economy is expected to grow strongly in 2007-08, after being affected by severe drought in 2006‑07. The global economy continues to be strong. The high level of business investment is expanding the capacity of the economy, and is expected to translate into accelerating export growth. Strong income growth is anticipated to support solid household consumption growth and a modest pick-up in dwelling investment. Employment growth is expected to ease in 2007-08, following a period of strength, and inflation is forecast to moderate.


The Australian economy strengthened towards the end of 2006, despite the severe impact of the drought. This strength is expected to be sustained over the forecast period. Real GDP is expected to grow by 3żáperácent in 2007-08, up from 2Żáperácent iná2006-07. The forecast for 2007-08 reflects an assumed return to average seasonal conditions and a partial recovery from the drought, which is expected to add Ż of a percentage point to GDP growth. Strong growth in 2007-08 also reflects solid growth in consumption and business investment, a modest increase in dwelling investment and accelerating export growth.

The Australian economy is adjusting well to the increasing global demand for mineral and energy resources, with a substantial reallocation of labour and capital currently underway. While mining production and export volumes have not yet grown significantly, reflecting the long lead times from mining investment to production, solid growth is expected from 2007-08. Over the past five years, the mining sector has invested around $55ábillion to expand production.

Prospects for the household sector have improved. While consumption grew modestly in 2005-06 and dwelling investment experienced a mild decline, growth is expected to strengthen in 2006-07 and 2007-08. This strengthening reflects the continued stimulus to household income and wealth from high commodity prices. Recent growth in household income reflects strong employment growth, which has accompanied a fall in the unemployment rate to 30-year lows and a rise in the participation rate to near-record highs. Employment growth is expected to moderate in 2007-08, and the unemployment rate is forecast to remain low.

Overall wage pressures are anticipated to remain contained, while inflation is expected to moderate. The forecast moderation in inflation reflects a stabilising of automotive fuel prices, the recent unwinding of large rises in fruit prices experienced during 2006 and an easing in underlying inflationary pressures.

The world economy is expected to continue to expand at a strong rate, with world GDP forecast to increase by 5áperácent in 2007 and 2008. The positive outlook reflects expectations for strong growth in China, India, Japan and the euro area. Growth in the United States is expected to ease in 2007, before strengthening in 2008.

In the domestic economy, household consumption is expected to grow by 3Żáperácent in 2006-07 and 2007‑08. Strong increases in household income and solid growth in wealth are expected to support consumption and allow households to further consolidate their balance sheets. Recent strong increases in household income reflect strong employment growth and solid wage growth.

Dwelling investment is expected to recover modestly after its recent mild fall, and grow by 2Żáperácent in 2006‑07 and 2007-08. Investment by owner-occupiers is expected to lead the recovery, with recent interest rate increases and low rental yields weighing more heavily on investors. An increase in rental yields is expected to encourage more investor activity during 2008.

The level of business investment is expected to remain high, although growth is likely to moderate from its recent strong rates. New business investment is forecast to increase by 7Żáperácent in 2007-08, underpinned by continuing strength in the mining and construction sectors. The investment environment remains favourable, although there is some evidence of capacity constraints in the construction sector with cost pressures and delays in obtaining labour and materials.

Public final demand is expected to grow by 3żáperácent in 2007-08, with strong growth in public investment and some moderation in public consumption growth.

Net exports are expected to subtract Ż of a percentage point from GDP growth iná2007-08. Significant growth in non-rural commodity exports is forecast in 2007-08, while growth in other exports is expected to be modest. Rural exports are forecast to make some recovery following the drought, while elaborately transformed manufactures and services exports are expected to be constrained by the relatively high exchange rate and continuing robust international competition. Import growth is expected to remain solid over the forecast period, consistent with the higher exchange rate and the outlook for domestic demand. Recent strong import growth is the counterpart of strong growth in investment and incomes in the economy.

The terms of trade reached their highest level in over 50 years in the December quarter 2006. They are expected to fall by 1Żáperácent in 2007-08, reflecting anticipated falls in rural and non-rural commodity prices as global supply increases in these markets.

The current account deficit (CAD) is forecast to widen to 6áperácent of GDP in 2007-08, with growth in import volumes forecast to outpace growth in export volumes, and export prices expected to fall. The anticipated widening in the trade deficit is expected to be partially offset by a narrowing in the net income deficit reflecting slower growth in corporate profits. From a saving and investment perspective, the expected widening in the CAD reflects expected higher investment and relatively unchanged national saving as a share of GDP.

Employment growth is expected to ease to 1Żáperácent in 2007-08, consistent with around-trend non-farm GDP growth and a modest rise in real labour costs. The participation rate is expected to rise to 65áperácent, while the unemployment rate is expected to increase modestly to 5áperácent in 2007-08. The forecast rise in the participation and unemployment rates partly reflects the new participation requirements for Disability Support Pension and Parenting Payment recipients, which are expected to result in more people entering the labour force.

Wage growth is expected to remain solid at 4╝áperácent in 2007-08. While there have been localised wage pressures in those sectors most affected by mining and construction activity, overall wage pressures remain contained.

Inflation is forecast to ease from 2żáperácent in 2006-07 to 2Żáperácent in 2007-08. Inflation is expected to temporarily fall below 2áperácent through the year to the June quarter 2007 as automotive fuel prices stabilise and fruit prices remain below the highs experienced in 2006. Underlying inflationary pressures are expected to moderate as nominal unit labour costs ease, reflecting improved productivity.

The risks confronting the Australian economy have become more evenly balanced in recent months. The risks are around the ongoing effects of the drought, the adjustment to the commodity price stimulus and the pace of household balance sheet consolidation.

The drought is expected to have a significant adverse impact on the economy iná2006-07, with 2006 being the driest year on record across parts of southern Australia. The forecast strength in the economy in 2007-08 partly relies on the normal budget assumption of average seasonal conditions. The timing and distribution of rainfall has an important impact on the prospects for rural production and exports, and the economy more broadly.

There is a downside risk to the outlook if rainfall for the farm sector remains inadequate. While the Bureau of Meteorology has announced the end of the 2006-07 EláNi˝o conditions and stated that there appears to be little chance of a return to these conditions in 2007, the ending of EláNi˝o does not necessarily imply drought-breaking rains. Further, the current low water storage levels will make it difficult for some parts of the farm sector to fully recover from drought. For example, there is a risk that farmers in the Murray-Darling Basin will have no water allocations in 2007-08, which would lead to a large fall in production in this region.

A long period of economic growth has absorbed much of the economy's spare capacity. In particular, the economy is as close to full employment as it has been for over 30áyears. There is evidence of capacity constraints in the construction sector, with some cost pressures and delays in obtaining labour and materials to complete projects. There is a risk that these factors will constrain output growth and place greater‑than‑anticipated upward pressure on prices and wages. Alternatively, productivity may be stronger than anticipated once the adjustment of the economy to the reallocation of labour and capital is completed, leading to stronger growth without additional price pressures.

While the risks around consumption and dwelling investment have become more balanced, there remains uncertainty about the pace of household balance sheet consolidation. While household balance sheets are sound in aggregate, concerns remain about the vulnerability of a small proportion of highly-geared households to unexpected changes in interest rates and incomes.

The outlook for the world economy remains positive, although a number of risks remain. These risks include a sharper-than-expected slowing in the United States, increased inflationary pressures, a substantial increase in oil prices, a greater-than-expected pick-up in financial market volatility, and a disorderly unwinding of global imbalances. While the current housing-led slowing in United States growth is expected to be mild, should the weakness become more broadly based this could have adverse implications for economies elsewhere.

Tableá1: Domestic economy forecasts(a)

Tableá1: Domestic economy forecasts(a)

  1. Percentage change on preceding year unless otherwise indicated.
  2. Calculated using original data.
  3. Chain volume measures.
  4. Excluding second-hand asset sales from the public sector to the private sector and including the impact of the privatisation of Telstra.
  5. Percentage point contribution to growth in GDP.
  6. For presentational purposes, inventories held by privatised marketing authorities are included with the inventories of the farm sector and public marketing authorities.
  7. The estimate in the final column is the forecast rate in the June quarter 2008.

Source: Australian Bureau of Statistics (ABS) cat. no. 5206.0, 5302.0, 6202.0, 6345.0, 6401.0, unpublished ABS data and Treasury.