Part 2: Economic Outlook (Continued)
The Australian economy continues to outperform every major advanced economy. The pace of economic growth accelerated in the first half of 2012, driven by a surge in resources investment and robust growth in household consumption. Above‑trend real GDP growth supported rising employment and a low unemployment rate, while underlying inflation remains contained.
Despite a weaker global outlook, Australia's economic growth prospects are favourable, with real GDP forecast to grow 3 per cent in both 2012‑13 and 2013‑14, underpinned by growth in new business investment, non‑rural commodity exports and household consumption. Compared with Budget, the growth forecast has been downgraded slightly (by ¼ of a percentage point) in 2012‑13, following stronger‑than‑anticipated growth in 2011‑12 and reflecting recent company announcements to defer or cancel some resources projects.
While real GDP is still forecast to grow around trend, sharp falls in the prices of some of Australia's key non‑rural export commodities — particularly iron ore and coal — and a more moderate outlook for domestic price inflation have driven a significant downward revision to forecast growth in nominal GDP in 2012‑13. Nominal GDP is now forecast to grow 4 per cent in 2012‑13 and 5½ per cent in 2013‑14.
Recent falls in global commodity prices have led to some scaling back of investment plans in the coal and iron ore sectors. Still, resources investment is expected to reach unprecedented levels, driving new business investment to record highs as a share of GDP over the forecast period. Australia's resources investment pipeline is dominated by LNG projects, where investment decisions are taken over long time horizons and are underpinned by projections of the energy needs of large Asian economies over a period of decades (see Box 2.3).
In value terms, over two‑thirds of the large resources projects included in the economic forecasts have received final investment approval, with the majority already under construction. Following 75 per cent growth in 2011‑12, the latest capital expenditure survey suggests a further 45 per cent increase in resources investment in 2012‑13.
The domestic growth outlook is also supported by strong forecast growth in non‑rural commodity export volumes. The surge in investment in the resources sector will drive expansions in production, which will lead to a ramp‑up in export volumes as major resources projects increasingly move from the investment phase to the production phase. Australia's non‑rural commodity exports are expected to grow 15 per cent over the next two years, notwithstanding a modest downgrade to forecast growth in coal exports since Budget, partly reflecting the early closure of a few high cost mines.
Solid growth in household consumption is also expected to underpin economic growth across the forecast period. Over the past year, the combination of robust growth in disposable income and weak consumer price inflation enabled households to enjoy above‑trend growth in real consumption, while maintaining high rates of saving. Looking ahead, the pace of household consumption growth is expected to remain solid, albeit moderating slightly, consistent with forecasts for moderate employment and wages growth, and subdued expectations for asset price growth. Reflecting this, the household saving ratio is expected to remain elevated across the forecast period.
Conditions in some parts of the economy remain difficult, reflecting weak global conditions, the continued high exchange rate, shifting patterns of household demand and the more restrained approach of households and businesses towards taking on new debt since the global financial crisis. These factors have placed downward pressure on prices and profitability in some sectors, despite solid growth in sales volumes. The retail sector is a case in point, with strong growth in sales volumes over the past year coinciding with below‑trend growth in revenue and falling profits across much of the sector.
Notwithstanding these pressures, domestic demand remains solid in aggregate and there are tentative signs that residential building activity may be starting to improve. As resources investment as a share of the economy passes its peak, the forecasts are for low interest rates and rising incomes to support modest growth in dwelling construction and non‑mining business investment in 2013‑14.
Employment growth is expected to pick up over the forecast period, but is forecast to remain below trend, as the above‑mentioned pressures on parts of the domestic economy and the uncertain global outlook continue to weigh on hiring decisions. Through‑the‑year employment growth is forecast to strengthen to 1 per cent to the June quarter 2013 and to 1¼ per cent to the June quarter 2014.
Australia's unemployment rate is forecast to remain low, albeit rising slightly from 5¼ per cent in the September quarter 2012 to 5½ per cent by the June quarter 2013, unchanged from Budget. The outlook for the unemployment rate is consistent with forecasts for below‑trend employment growth and a stable workforce participation rate, which remains high in historical terms despite recent falls. Australia's low unemployment rate stands in stark contrast to most major advanced economies, at around half the rate in the euro area and significantly less than the almost 8 per cent unemployment rate in the United States.
The outlook for trend growth in the Australian economy over the next two years factors in the fiscal consolidation being undertaken by the Commonwealth and state governments. As is standard practice, the forecasts assume policy interest rates move broadly in line with market expectations at the time that the forecasts are finalised, with the market expectation at that time being that policy interest rates would be lower over the coming year. The planned fiscal consolidation should continue to provide scope for monetary policy to be eased, if appropriate, without generating price and wage pressures. The impact of the fiscal consolidation, particularly in 2012‑13, should be more than offset by growth in private demand, with the aggregate economy growing around trend.
Domestic inflationary pressures have eased in recent quarters, with underlying consumer price inflation falling to the bottom of the Reserve Bank's target band and investment prices growing at a subdued rate in aggregate. Headline inflation is forecast to rise to 3 per cent through the year to the June quarter of 2013 (including an estimated one‑off ¾ of a percentage point increase from the introduction of the carbon price), before easing to 2¼ per cent through the year to the June quarter of 2014. Likewise, underlying inflation is expected to be moderate, at 2½ per cent through the year to the June quarter of 2013 (including a one‑off ¼ of a percentage point addition stemming from the carbon price) and 2¼ per cent through the year to the June quarter of 2014.
While the Budget factored in a decline in Australia's terms of trade, the fall in global commodity prices over recent months has been larger than anticipated (see Box 2.1). Global commodity prices have been highly volatile in recent months, with spot prices for Australia's key non‑rural commodity exports (iron ore and thermal and metallurgical coal) falling between 15 and 33 per cent since Budget. A partial recovery has been built into the near‑term forecasts for iron ore and coal prices, largely reflecting an anticipated recovery in iron ore demand as the destocking process in China runs its course. The increase in iron ore prices since mid‑September also suggests that prices had fallen below levels consistent with market fundamentals. Even allowing for this near‑term recovery, the forecasts for non‑rural commodity prices are lower than at Budget, consistent with the weaker economic outlook globally, and for China in particular. Consequently, Australia's terms of trade are expected to be lower over the forecast period than expected at Budget, albeit remaining high by historical standards (Chart 2.1).
Chart 2.1: Terms of trade
Source: ABS cat. no. 5206.0 and Treasury.
The terms of trade are now expected to fall 8 per cent in 2012‑13, a larger fall than the decline of 5¾ per cent forecast at Budget. In line with the ongoing expansion in global supply of Australia's key non‑rural commodity exports, the terms of trade are expected to continue to ease in 2013‑14, with a forecast fall of 2¾ per cent, similar to that forecast at Budget. Notwithstanding these expected falls, Australia's terms of trade are projected to remain above their long‑term average in the medium term, consistent with the projected resources needs of the large emerging market economies in the Asian region.
While Australia's economic outlook is positive, the external environment remains fragile and the risks to the global economy are firmly on the downside. The outlook for the euro area remains uncertain, with fears that the sovereign debt crisis could escalate into a major monetary and financial crisis. The impending fiscal cliff in the United States also remains a downside risk to the global economic outlook, with the possibility of a recession in the United States economy if no resolution is reached. In China, the prospects of a weaker contribution from the export sector to economic growth and the risks to global economic and financial stability emanating from the major advanced economies complicate the authorities' already challenging macroeconomic management task, raising the prospect of a sharper‑than‑planned slowdown in economic growth. In this context, there is a risk that non‑rural commodity prices and Australia's terms of trade could decline more rapidly than currently forecast, with attendant risks to nominal GDP growth.
|Panel A - Demand and output(c)|
|Total business investment(d)||21.3||12 1/2||11||8||6 1/2|
|Non-dwelling construction(d)||39.0||14||14||7 1/2||5 1/2|
|Machinery and equipment(d)||10.6||12 1/2||9||8 1/2||7 1/2|
|Private final demand(d)||6.7||5||4 3/4||4 1/4||4|
|Public final demand(d)||1.1||- 1/2||- 1/2||0||- 1/4|
|Total final demand||5.3||3 3/4||3 1/2||3 1/4||3|
|Change in inventories(e)||0.2||0||0||0||0|
|Gross national expenditure||5.5||4||3 3/4||3 1/2||3 1/4|
|Exports of goods and services||3.7||4 1/2||4 1/2||4 1/2||4|
|Imports of goods and services||11.8||7 1/2||7||5 1/2||5|
|Net exports(e)||-1.8||- 3/4||- 3/4||- 1/2||- 1/4|
|Real gross domestic product||3.4||3 1/4||3||3||3|
|Non-farm product||3.3||3 1/4||3 1/4||3||3|
|Nominal gross domestic product||5.0||5||4||5 1/4||5 1/2|
|Panel B - Other selected economic measures|
|Terms of trade||1.8||-5 3/4||-8||-3 1/4||-2 3/4|
|Current account balance (per cent of GDP)||-2.8||-4 3/4||-5||-6||-5 3/4|
|Employment(f)||0.7||1 1/4||1||1 1/2||1 1/4|
|Unemployment rate (per cent)(g)||5.1||5 1/2||5 1/2||5 1/2||5 1/2|
|Participation rate (per cent)(g)||65.3||65 1/4||65||65 1/4||65|
|Prices and wages|
|Consumer price index(h)||1.2||3 1/4||3||2 1/2||2 1/4|
|Gross non-farm product deflator||1.7||1 3/4||1||2 1/4||2 1/2|
|Wage price index(f)||3.7||3 3/4||3 1/2||3 3/4||3 1/2|
(a) Percentage change on preceding year unless otherwise indicated.
(b) Calculated using original data unless otherwise indicated.
(c) Chain volume measures except for nominal gross domestic product which is in current prices.
(d) Excluding second‑hand asset sales from the public sector to the private sector.
(e) Percentage point contribution to growth in GDP.
(f) Seasonally adjusted, through‑the‑year growth rate to the June quarter.
(g) Seasonally adjusted rate for the June quarter.
(h) Through‑the‑year growth rate to the June quarter.
Source: ABS cat. no. 5206.0, 5302.0, 6202.0, 6345.0, 6401.0, unpublished ABS data and Treasury.
Note: The forecasts are based on several technical assumptions. The exchange rate is assumed to remain around its recent average level — a trade‑weighted index of around 75 and a United States dollar exchange rate of around 102 US cents. Interest rates are assumed to move in line with market expectations. World oil prices (Malaysian Tapis) are assumed to remain around US$118 per barrel. The farm sector forecasts are based on an assumed return to average seasonal conditions.
Box 2.1: Commodity prices
Spot prices for Australia's key non‑rural commodity exports (iron ore, and thermal and metallurgical coal) have fallen between 15 and 33 per cent since Budget. While coal and iron ore prices remain high by historical standards, the recent falls exceed the declines forecast at Budget and are reflected in weaker forecasts for the terms of trade, nominal GDP and tax receipts.
Thermal coal prices have fallen 15 per cent since Budget, reflecting subdued global demand for coal use in electricity generation, including in response to low gas prices in the United States, and greater global coal supplies becoming available in the Asian market.
Metallurgical coal and iron ore prices, while highly volatile, have also fallen significantly since the start of the financial year. The iron ore spot price fell around 38 per cent in US dollar terms between Budget and the first week of September, before recovering around two thirds of this fall by the second week of October (Chart A).
Chart A: Iron ore spot price
Iron ore and metallurgical coal are the main inputs to steel production and the price falls largely reflect weaker demand for steel, consistent with subdued conditions in the major advanced economies and recent moderation of steel demand growth in the emerging market economies of Asia (Chart B).
Lower steel prices in China also reflect overcapacity in the Chinese steel industry, which has added to the seasonal destocking of iron ore and coal that takes place in the third quarter. Restocking generally picks up in the fourth quarter. Nevertheless, the outlook for steel demand is uncertain and sensitive to developments in the steel‑intensive Chinese property market and the form and size of any further Chinese policy stimulus.
Chart B: China steel price
Lower commodity prices are putting pressure on higher cost mining operations. The marginal sources of iron ore are largely overseas, with Australian mines generally having comparatively low costs of production.
Some Australian coal mines are under pressure at current prices, with isolated closures already taking place. While not the central forecast, a prolonged period of low prices could have a further impact on production.
A fall in supply and some recovery in demand are expected to generate a modest near‑term recovery in prices for metallurgical coal and iron ore. However, iron ore and metallurgical coal prices are expected to remain below the Budget estimates across the forecast period, consistent with a more moderate outlook for China's economic growth and resources demand. Thermal coal spot prices have stabilised recently and are expected to remain around their current levels, although a large proportion of Australia's exports of thermal coal are priced using annual contracts that were set in March 2012 (Chart C). This contract price is significantly above the current spot price and will prevail until March 2013.
Chart C: Thermal coal spot price
Considered from a medium‑term perspective, commodity prices are still expected to be elevated by historical standards, and will still provide an incentive to continue the expansion of low cost supplies in Australia and around the world. In Australia, around $65 billion of coal and iron ore projects are committed or have already commenced construction. While substantial, this represents around a quarter of the advanced pipeline of resources investment, which is dominated by LNG projects (see Box 2.3). The medium‑term projections for the terms of trade are based on a gradual decline in commodity prices as the supply of iron ore and coal steadily comes on line. This medium‑term methodology has been retained from the 2012‑13 Budget.
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