Statement 2: Economic Outlook
Powerful countervailing forces are confronting the Australian economy. Slower global growth, tighter credit conditions and higher interest rates are expected to slow Australia's economic growth. Counteracting this, robust growth in emerging economies is supporting large rises in Australia's terms of trade, providing further stimulus to incomes and contributing to already heightened price pressures.
Overview
After a sustained period of strong growth, the global economy is expected to slow in 2008 and 2009. A sharp slowdown in the US economy is now evident in official data, with implications for growth in other countries, including Australia. Turbulence in global financial markets also remains an impediment to global growth, particularly in advanced economies.
These global developments come at a time when several years of strong demand in the Australian economy has not been matched by a commensurate expansion in supply capacity. This has led to a significant build‑up in underlying inflationary pressures. In response, the Reserve Bank of Australia has tightened monetary policy substantially.
The slowdown in global growth, tighter credit conditions and significantly higher interest rates are expected to slow growth in the Australian economy. As a result, conditions in the labour market are expected to ease, with some rise in the unemployment rate. Tighter monetary and fiscal policies are expected to gradually ease underlying inflation from 16‑year highs.
While the outlook for the global economy has weakened, areas of strength remain, particularly in emerging economies. The Chinese economy has so far remained largely insulated from negative developments elsewhere, reflecting both its lower level of integration into world capital markets and its substantial capacity for internally generated growth. Demand from China and other emerging economies is supporting large rises in non‑rural commodity prices, particularly for iron ore and coal and, as a result, Australia's terms of trade are forecast to reach new highs. This will lead to an acceleration in domestic incomes, which will contribute to already heightened price pressures.
Slower global growth and financial market turbulence, and the further stimulus from the terms of trade, are powerful opposing forces buffeting the economy. On balance, these forces, combined with the significant tightening in monetary policy that has occurred over recent years, are likely to result in a slowing in real GDP growth even as income growth remains high.
Summary of forecasts
Global growth, in real terms, is expected to be 4 per cent in 2008 and 2009. Growth in the advanced economies is expected to slow significantly, while the emerging economies are forecast to grow robustly, notwithstanding some slowing from growth rates recorded in recent years.
Australia's real GDP is forecast to increase by 2¾ per cent in 2008‑09. The non‑farm economy is forecast to grow by 2¼ per cent, while the farm sector is forecast to contribute ½ of a percentage point to growth given a recovery from drought. It is expected that the main contributors to growth will be household consumption and business investment, with net exports subtracting 1 percentage point from growth.
Household consumption is expected to grow by 2¾ per cent in 2008‑09. Significantly higher interest rates, tighter credit conditions, an easing in labour market conditions and confidence impacts from uncertainty in global financial markets are expected to weigh on consumption.
Dwelling investment is also expected to be affected by higher interest rates and tighter credit conditions, with growth forecast to be a subdued 2 per cent in 2008‑09. Most of the growth is likely to come from alterations and additions. Higher interest rates are expected to result in slower house price growth, and subdued dwelling investment will continue to add pressure to rents.
Business investment is expected to grow by 8½ per cent in 2008‑09. The outlook for both machinery and equipment and non‑dwelling construction is favourable, but the risks around these forecasts are heightened. Businesses are facing higher interest rates, and labour and material cost pressures persist. The potential for further deterioration in global capital markets is a risk for the business investment outlook.
Public final demand is forecast to grow by 3 per cent in 2008‑09. The slowing in growth reflects a moderation in Australian Government consumption expenditure and a slowing in State and local government investment from high growth rates in 2007‑08.
Exports are expected to grow by 6 per cent in 2008‑09, with more than three quarters of this growth coming from commodity exports. Rural exports are expected to rebound as the farm sector recovers from drought, while the increase in non‑rural commodity exports reflects the continuing ramp‑up and commencement of mining investment projects. Growth in exports of elaborately transformed manufactures and services is expected to be subdued, given the higher exchange rate and slower global growth.
Imports are forecast to grow by 9 per cent in 2008‑09, with the moderation in growth from 11 per cent in 2007‑08 reflecting an easing in the non‑farm economy. It is expected that growth in consumption and services imports will ease as household consumption slows, and intermediate imports will ease as domestic production slows. However, strong growth in business investment is expected to support capital imports.
The terms of trade are expected to rise by a strong 16 per cent in 2008‑09, from levels that are already the highest in more than 50 years. Australian coal contracts have recently been settled for US dollar price increases in the range from 125 to 240 per cent, while iron ore contract prices are expected to increase by at least 65 per cent in US dollar terms. In contrast, falls in base metal prices are expected, with the slowdown in global growth adding more uncertainty to this outlook. Rural prices and import prices are also expected to support the terms of trade.
The current account deficit is forecast to narrow to 5 per cent of GDP in 2008‑09, reflecting higher expected national saving as a share of GDP and relatively unchanged national investment. A small trade surplus is forecast given the strong rise in the terms of trade. The net income deficit is likely to widen significantly. This reflects strong growth in corporate profits, particularly mining profits, and rising net interest payments from a higher stock of net foreign debt.
Employment growth is expected to moderate to 1¼ per cent in 2008‑09. The participation rate is forecast to average 65¼ per cent, and the unemployment rate is expected to average 4½ per cent. The unemployment rate is forecast to rise to 4¾ per cent by the June quarter 2009, as conditions in the labour market ease. This reflects an easing in non‑farm GDP growth due to slower global growth, tighter credit conditions and higher interest rates.
Wages are expected to grow by 4¼ per cent in 2008‑09, which is in line with wage price growth in recent times. While wages are expected to grow strongly, they are not forecast to accelerate given the anticipated easing in labour market conditions.
Inflation is forecast to be 4 per cent through the year to the June quarter 2008. Strong demand in the Australian economy, which has not been matched by a commensurate increase in supply capacity, has led to a build‑up in underlying inflation. Upward pressure is also expected from the continuing effects of recent increases in oil prices and from specific items such as food and housing costs. Tighter monetary and fiscal policies are expected to gradually ease underlying inflation from 16‑year highs. Inflation is forecast to be 3¼ per cent through the year to the June quarter 2009.
Nominal GDP is forecast to grow by 9¼ per cent in 2008‑09, which would be its fastest rate of growth since the late 1980s. The growth reflects real GDP growth of 2¾ per cent and growth in broader economy prices — the GDP deflator — of 6¼ per cent, largely due to significant rises in non‑rural commodity export prices.
Table 1: Domestic economy forecasts(a)
- The forecasts are based on several technical assumptions. The exchange rate is assumed to be around 93 US cents, with a trade weighted index of around 71. Domestic interest rates are assumed to remain unchanged. World oil prices (West Texas Intermediate) are assumed to be around US$115 per barrel. Farm sector forecasts assume average seasonal conditions, but account for low water storage levels.
- Calculated using original data.
- Chain volume measures except for nominal gross domestic product which is in current prices.
- Excluding second‑hand asset sales from the public sector to the private sector and including the impact of the privatisation of Telstra.
- Percentage point contribution to growth in GDP.
- The estimate in the final column is the forecast rate in the June quarter 2009.
- Through the year growth rate to the June quarter for 2006‑07 and 2007‑08.
Source: Australian Bureau of Statistics (ABS) cat. no. 5206.0, 5302.0, 6202.0, 6345.0, 6401.0, unpublished ABS data and Treasury.
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