Australian Government, 2007–08 Budget

Domestic economy forecasts

The domestic economy forecasts are based on several technical assumptions. The exchange rate is assumed to remain around its average level of recent months — a trade weighted index of around 67.5 and a United States dollar exchange rate of around 85 US cents. Domestic interest rates are assumed to remain unchanged at current levels. World oil prices (West Texas Intermediate) are assumed to move in line with market expectations and remain around US$75 per barrel on average over the forecast period. The farm sector forecasts are based on an assumption of average seasonal conditions in the future, but take into account weather outcomes experienced in the early part of 2007‑08 and the current very low water storage levels.

The Australian economy is forecast to grow by 4¼ per cent in 2007‑08 and 3½ per cent in 2008‑09. The key domestic economy forecasts are summarised in Table 5.

Table 5: Domestic economy forecasts(a)

Table 5: 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.

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 no. 5206.0, 5302.0, 6202.0, 6345.0, 6401.0, unpublished ABS data and Treasury.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 4¼ per cent in 2007‑08, stronger than forecast at Budget, before moderating in 2008‑09. The upward revision reflects a more positive outlook for household incomes, largely as a result of stronger anticipated employment growth. Household income growth is expected to outpace consumption growth and hence the household saving ratio is anticipated to rise. The recent interest rate rise, combined with the possible impact of increased credit market spreads on household borrowing costs, will have a moderating effect on consumption.

Dwelling investment is expected to continue its modest recovery in 2007‑08, with forecast growth of 3 per cent. Dwelling approvals and housing finance data indicate a modest near‑term outlook for dwelling investment, with the recent interest rate rise and uncertainty around the flow‑on effects from the US sub‑prime housing market likely to be weighing on the market. Further, there are also ongoing supply constraints on dwelling investment. However, the indicators of underlying housing demand remain strong, supported by strong population growth. As such, dwelling investment growth is expected to pick‑up in 2008‑09.

Business investment is expected to grow by 9½ per cent in 2007‑08, with the outlook for both machinery and equipment, and engineering construction investment improving since Budget. The Australian Bureau of Statistics' Survey of Private New Capital Expenditure and Expected Expenditure suggests broad strength in plant and equipment investment in the period ahead. Strength in new engineering construction investment reflects planned new projects and a record amount of work under construction. Strong corporate balance sheets and profits will continue to support high levels of business investment. However, the recent global financial market volatility has put some upward pressure on financing costs. This is likely to result in slightly lower levels of investment than would have otherwise been the case.

Public final demand is expected to grow by 4½ per cent in 2007‑08, stronger than expected at Budget. State and local government investment is expected to increase strongly, reflecting a large number of infrastructure projects. Public consumption growth is expected to remain solid.

Net exports are expected to subtract 1 percentage point from GDP growth in 2007‑08, a larger subtraction than forecast at Budget. While a recovery in export volumes is expected, imports are forecast to grow more strongly, consistent with stronger consumption and higher investment. Significant growth in non‑rural commodity exports is expected, while rural exports are anticipated to be constrained by the weakness in farm production. Elaborately transformed manufactures and services exports are expected to grow solidly, although the uncertainty around the world outlook poses some downside risk.

The terms of trade are expected to rise modestly by 1¼ per cent in 2007‑08, rather than fall slightly as forecast at Budget. The upward revision largely reflects anticipated strength in Australia's bulk commodity export prices, with world demand expected to outpace supply in iron ore and coal markets. Falls in base metal prices are expected, in line with increasing global supply in these markets. While world growth is expected to support increases in commodity prices, there is a risk that weaker‑than‑expected world demand could have a significant negative impact on prices.

The current account deficit (CAD) is forecast to widen to 6¼ per cent of GDP in 2007‑08, reflecting expected higher investment and relatively unchanged national saving as a share of GDP. The net income deficit component of the CAD is expected to widen, reflecting growth in corporate profits and rising net interest payments from a higher stock of net foreign debt.

Employment growth is expected to be 2¼ per cent in 2007‑08, consistent with strong GDP growth. The participation rate is expected to rise to 65¼ per cent, while the unemployment rate is forecast to rise modestly from current levels to 4½ per cent. The rise in the participation and unemployment rates partly reflects the new eligibility and participation requirements for Disability Support Pension and Parenting Payment recipients. Employment growth is expected to moderate in 2008‑09, in line with a moderation in economic growth and higher near‑term growth in labour costs.

Wages are expected to grow by 4¼ per cent in 2007‑08 and 2008‑09. Strong wage growth is expected to continue in the States and industries most directly affected by robust mining and construction activity. Wage growth is expected to ease over the forecast horizon to 4 per cent through the year to the June quarter 2009.

Inflation is forecast to be 2¾ per cent in 2007‑08 and 2008‑09. In through‑the‑year terms, inflation is forecast to ease to 2½ per cent in the June quarter 2009. There are some inflationary pressures, with low water allocations in the Murray‑Darling Basin and ongoing dry weather, combined with one‑off weather events such as frost, contributing to higher food prices. Underlying inflationary pressures are expected to ease over the forecast horizon in line with moderating domestic demand, increases in the economy's supply potential and lower growth in unit labour costs.