Australian Government, 2007–08 Budget

Part 3: Economic outlook

The Australian economy is expected to grow by 4¼ per cent in 2007‑08, stronger than the 3¾ per cent forecast at Budget. The economy's supply potential is expected to expand at a faster‑than‑usual pace, reflecting strong and sustained business investment. Growth in export volumes is forecast to accelerate as increased capacity comes on line. The prospects for the household sector are favourable, buoyed by growth in incomes and wealth. The forecast for 2007‑08 also reflects a partial recovery from the drought, which is expected to add ½ of a percentage point to GDP growth.

The economic forecasts have been framed against a backdrop of significant turbulence in global financial markets. Rising default rates on sub‑prime mortgages in the United States have led to reduced liquidity and increased volatility in world financial markets. The ongoing implications of this turbulence for the domestic and world economies are uncertain, introducing greater risks to the outlook. These events have occurred at a time when there has been significant momentum in the domestic and global economies.

World GDP is forecast to grow by 5 per cent in 2007 and 4¾ per cent in 2008. The slight downward revision to the outlook for 2008 from the Budget forecast of 5 per cent reflects weaker growth in the United States. Growth is expected to be strong across emerging market economies, and demand from these regions is expected to continue to support export growth in major developed economies.

The Australian economy will continue to be influenced by strong global demand for mineral and energy resources. Business investment grew by 7.1 per cent in 2006‑07, following double‑digit growth in each of the preceding four years. The increase in commodity prices has boosted mining profits and investment. Investment is also strong in other sectors such as manufacturing, and property and business services. A continuation of strong business investment is forecast for 2007‑08 and 2008‑09. The strength of corporate balance sheets and profits will continue to support high levels of business investment, notwithstanding possible upward pressure on financing costs as a result of recent financial market developments.

Growth in mining production and export volumes is expected to accelerate from 2007‑08 as projects come on line. The mining industry has invested $76 billion over the past six years and strong investment is expected to continue. Nominal business investment as a share of GDP is at its highest level in 33 years and is anticipated to remain around this level.

The terms of trade are forecast to rise modestly by 1¼ per cent in 2007‑08, rather than fall slightly as expected at Budget. The upward revision largely reflects anticipated strength in the prices of Australia's bulk commodity exports of iron ore and coal. World demand is expected to outpace supply in these markets. In contrast, falls in base metal prices are expected as global supply in these markets increases. The increased downside risks to the world economy create more uncertainty around the outlook for commodity prices.

Ongoing growth in household incomes, wealth and employment is expected to result in strong household consumption growth, and a pick‑up in dwelling investment growth in 2008‑09. Household incomes are expected to be higher than forecast at Budget. Employment growth is forecast to be strong, supported by strong domestic demand, high participation and increased immigration.

Wage and inflation pressures are expected to ease over the forecast horizon. Current pressure on food prices reflects unfavourable weather conditions and low water allocations in the Murray‑Darling Basin. An easing in underlying inflation is expected as demand pressures ease and growth in unit labour costs slows as productivity strengthens.