Australian Government, 2010‑11 Budget

Statement 2:
Economic Outlook

The outlook for the domestic economy

Demand and output

The recovery in the domestic economy is expected to continue gathering pace, with real GDP forecast to grow by 3¼ per cent in 2010‑11 and 4 per cent in 2011‑12. With strengthening growth, the economy is expected to approach full capacity in 2011‑12, significantly earlier than previously anticipated (Box 2).

The global recovery is generating strong demand for non‑rural commodities, particularly from Asia, resulting in higher prices. The resulting boost to domestic incomes is expected to spur business investment and household consumption. While fiscal stimulus supported growth through 2009, it will detract from growth through 2010 and 2011 as it is phased out. Export volumes are expected to grow strongly, driven by demand for non‑rural commodities. The recovery in domestic incomes and the assumed ongoing strength of the Australian dollar are expected to see strengthening demand for imports (Chart 3).

Chart 3: Contributions to forecast GDP growth

Chart 3: Contributions to forecast GDP growth

Note: Business investment and public expenditure are adjusted for second‑hand asset sales from the public sector to the private sector.

Source: ABS cat. no. 5206.0 and Treasury.

Box 2: Australia's recent growth performance

Well‑timed monetary and fiscal policy stimulus in Australia ensured that the economy's deviation from potential was kept to a minimum. As a result, the recent downturn in Australia has been particularly mild compared with the experience of the rest of the world.

GDP growth remained positive in Australia, whereas through the year to June 2009, the UK economy contracted by 5.9 per cent, and the US economy by 3.8 per cent (Chart A).

Chart A: GDP growth

Chart A: GDP growth

Source: ABS cat. no. 5206.0 and Ecowin.

Prior to the global economic downturn, Australia's economy was growing above trend, with growth in 2007‑08 of 3.7 per cent. The unemployment rate dropped to 4.0 per cent in early 2008.

In the economic downturn, growth slowed to 1.3 per cent in 2008‑09, and is expected to remain below trend at 2 per cent in 2009‑10. However, growth is forecast to pick up in 2010‑11 and 2011‑12, and the economy is expected to return to around its full employment level of output (Chart B).

Chart B: Australian trend and forecast GDP

Chart B: Australian trend and forecast GDP

Note: Trend growth is based on the assumption of 1½ per cent growth in both the labour force and productivity. The trend lines in Chart B and Chart C start from a period when each economy was operating at around its capacity.

Source: ABS cat. no. 5206.0 and Treasury.

This contrasts with most of the advanced economies, including the US, which are expected to operate below their potential for years to come (Chart C).

Chart C: US trend and forecast GDP

Chart C: US trend and forecast GDP

Source: Ecowin, Treasury and the Congressional Budget Office.

Household consumption

Household consumption has continued to grow solidly in recent months, notwithstanding the withdrawal of fiscal stimulus and rising interest rates. The fall in consumer confidence during the downturn was severe but quickly arrested and the limited deterioration in labour market conditions also helped support demand. Household wealth declined, but has subsequently retraced most of the fall on the back of solid growth in equity and house prices, with net wealth growing by 9.2 per cent over the six months to September 2009 (the latest available data). In particular, household financial assets have recovered, growing by 15¼ per cent since the recent trough (Chart 4).

Chart 4: Growth in household financial assets

Chart 4: Growth in household financial assets

Source: ABS cat. no. 5232.0 and 5206.0.

A strong labour market and stronger incomes, sustained improvements in consumer confidence and higher asset prices should underpin continued solid growth in household consumption. Household consumption is expected to grow by 3½ per cent in 2010‑11 and 4 per cent in 2011‑12.

Dwelling investment

A strong recovery in dwelling investment is expected over the next year, with growth of 7½ per cent forecast in 2010‑11, followed by solid growth of 4 per cent in 2011‑12. Earlier increases in housing approvals and housing finance, supported by historically low interest rates, are expected to flow through to investment activity in the near term (Chart 5).

Demand in the sector is expected to be supported over the forecast period by strong population growth, rising incomes and a positive employment outlook, but tempered by higher mortgage interest rates. While buoyant conditions in the established market should encourage an increase in building activity, ongoing supply constraints may slow investment in the sector.

Chart 5: Growth in dwelling investment

Chart 5: Growth in dwelling investment

Source: ABS cat. no. 5206.0 and Treasury.

Business investment

New business investment is expected to recover strongly over the forecast period, led by an expected surge in mining investment. New business investment is forecast to grow by 7 per cent in 2010‑11, and by 12½ per cent in 2011‑12. This is expected to see total business investment approach its recent highs as a proportion of GDP (Chart 6). The recovery in business investment is expected to be driven by investment in machinery and equipment, and engineering construction, while non‑residential building investment is expected to remain subdued.

Chart 6: New business investment as a share of nominal GDP

Chart 6: New business investment as a share of nominal GDP

Source: ABS cat. no. 5206.0 and Treasury.

Reflecting the improved outlook, survey measures of business conditions and confidence have generally tracked above long‑run averages since late 2009, with confidence currently around eight‑year highs. There are also indications that the production and inventory cycles have reached their turning points. As business conditions recover further and the economy's spare capacity is absorbed, businesses are expected to resume spending to expand capacity to satisfy future demand growth.

An unwind of the effect of the Small Business and General Business Tax Break is expected to have slowed machinery and equipment investment in early 2010, but a recovery in underlying investment is expected in the near term. Investment in new machinery and equipment is expected to rise significantly over the forecast horizon as firms resume necessary maintenance and asset replacement programs that were delayed during the downturn. The recovery is expected to gather momentum through 2010‑11 and 2011‑12, with growth in these years of 6 per cent and 13 per cent respectively.

Investment in new engineering construction is also expected to grow strongly over the forecast horizon as a number of major resource projects commence. Recent data indicate particular strength in investment intentions for 2010‑11 in the mining sector. Mining‑related investment is expected to drive investment in engineering construction, with extremely robust growth of 19 per cent forecast in 2010‑11 and 20½ per cent in 2011‑12. With strong growth expected in the LNG sector, and further major resource projects in the pipeline, engineering construction investment is expected to continue to grow significantly as a share of total business investment over coming years (Box 3).

In the long run, the Resource Super Profits Tax (RSPT) is expected to lead to an increase in resource sector investment, with the crediting of royalties effectively removing the distortionary effect they have had on investment and production.

These benefits could be muted in the transition phase, although projects that are, or would have otherwise been, subject to the petroleum resource rent tax (which includes new offshore LNG investment) will have the option of remaining under the existing arrangements.

Investment in new non‑residential building, by contrast, is expected to remain subdued. Outside of stimulus‑related activity, there is a limited pipeline of work in the building sector, reflecting credit constraints, high vacancy rates and soft property prices. Despite support from the Government's Building the Education Revolution program, investment in this sector has fallen sharply over the past year. This weakness is expected to continue into 2010‑11 with investment forecast to fall by a further 6½ per cent. As commercial property vacancy rates stabilise and previously built floor space is absorbed through the broader economic recovery, building approvals are expected to recover during 2011, leading to renewed activity in the sector. This is expected to lead to a modest recovery in investment in 2011‑12, with growth of 4 per cent.

Box 3: The LNG sector

A key driver of the expected surge in mining investment over coming years will be investment in liquefied natural gas (LNG). Global demand for gas is expected to increase markedly over the longer term, particularly from Asia.

There are currently around a dozen large‑scale LNG projects under construction or active consideration in Australia, which have the potential to increase Australia's LNG production capacity four fold.

These projects are led by the massive Gorgon development which commenced construction in the December quarter 2009. With an expected capital expenditure of $43 billion, Gorgon is the largest resource project ever undertaken in Australia.

During construction, Gorgon will provide a significant boost to private investment and employment and require the importation of significant quantities of capital goods. The developer has estimated that around $20 billion will be spent on locally sourced goods and services over the next four to five years. The project is also expected to support around 10,000 workers, both directly and indirectly, during construction.

Once operational, Gorgon will also provide a longer‑lasting contribution to the economy through higher export volumes and export incomes.

In addition to Gorgon, other large‑scale LNG projects currently in the pipeline include offshore gas developments in Western Australia and the Northern Territory such as Ichthys LNG, Browse LNG and Wheatstone LNG; along with coal seam gas to LNG projects in Queensland including Queensland Curtis LNG, Gladstone LNG and Australia Pacific LNG.

A number of projects are progressing towards final investment approval during 2010 and 2011.

While it is not possible to know the outcome of future investment decisions, it is plausible that LNG investment could increase to around 3 per cent of GDP by 2013‑14. This would roughly double current levels of engineering construction investment in Australia (Chart A).

Chart A: Potential capital expenditure on LNG projects

Chart A: Potential capital expenditure on LNG projects

Source: Treasury.

According to ABARE estimates, the value of Australia's LNG exports is projected to reach $13.5 billion by 2014‑15.

Public final demand

New public final demand is forecast to grow by 7¼ per cent in 2009‑10, then by 1 per cent in 2010‑11 and fall by ½ of a per cent in 2011‑12. This profile of activity is driven by the fiscal stimulus measures and their subsequent withdrawal.

Australian Government spending was critical to supporting the economy through 2009, contributing around 2 percentage points to annual GDP growth. The estimated peak impact of the fiscal stimulus on GDP growth occurred in the June quarter 2009. The stimulus is now being steadily withdrawn and is expected to detract from economic growth from the March quarter 2010, and into 2010‑11 and 2011‑12 (Chart 7). The stimulus will detract around 1 percentage point from GDP growth over 2010 and ¾ of a percentage point over 2011 (Box 4).

High levels of state and territory government spending on public works are also set to be scaled back from 2010‑11 after an expected peak in 2009‑10. Fiscal consolidation at all levels of government is expected to result in a moderation of growth in public consumption spending over 2010‑11.

Chart 7: Estimated contribution of stimulus to GDP growth

Chart 7: Estimated contribution of stimulus to GDP growth

Source: ABS cat. no. 5206.0 and Treasury.

Box 4: Economic growth and fiscal stimulus

Chart A: Economic growth and fiscal stimulus, 2009

Chart A: Economic growth and fiscal stimulus, 2009

Note: Forecast error is actual growth minus IMF forecast growth.

Source: IMF World Economic Outlook Database April 2009, 2010, IMF Fiscal Monitor November 2009 and Treasury.

The 2009‑10 Budget forecasts were framed at a time of remarkable volatility and uncertainty in the global economy. A deep global recession was underway and the Australian economy was expected to contract, despite the substantial monetary and fiscal stimulus that had been put in place.

At the time the Budget forecasts were being finalised in April 2009, the IMF forecast that advanced economies would contract by 3.8 per cent in 2009 and that the Australian economy would contract by 1.4 per cent.

While the IMF's forecasts for advanced economies turned out to be reasonably accurate (advanced economies contracted by 3.2 per cent), the forecast for Australia turned out to be overly pessimistic, with the Australian economy growing by 1.4 per cent in 2009. Other forecasters, including the Treasury, also turned out to be too pessimistic.

Several contributing factors help to explain the better performance by Australia, including the strength of our financial system, the timely and substantial monetary and fiscal stimulus, and the support provided by our close links to Asia, where growth was supported by China's large stimulus.

It appears that the impact on economic growth of the fiscal stimulus that countries, such as Australia, put in place has exceeded expectations. Forecasters used conservative fiscal multipliers, in part because of the heightened uncertainty, significant falls in business and consumer confidence, and extreme risk aversion in financial markets.

As events turned out, the fiscal multipliers in those countries that enacted large and timely fiscal stimulus packages appear to have been larger than expected.

Chart A shows, for 2009, the relationship between the size of a country's fiscal stimulus and the extent to which economic growth exceeded the IMF's April 2009 forecast.

Those countries that enacted large and timely fiscal stimulus packages, including China, Korea and Australia, performed much better than expected. Those countries with smaller packages, such as the US, Germany, Canada and France, tended to perform broadly in line with expectations. The relationship shown is highly statistically significant, with a t‑statistic on the slope coefficient of 3.3.

Exports and imports

Export volumes are expected to increase over the forecast period, in line with the anticipated recovery in global economic activity. Export volumes are forecast to grow by 5 per cent in 2010‑11 and 6 per cent in 2011‑12.

Exports of non‑rural commodities are expected to drive aggregate export growth over the forecast period, increasing by 3½ per cent in 2009‑10, 8 per cent in 2010‑11 and 7½ per cent in 2011‑12. Strengthening commodity demand has been driven by a recovery in global industrial production, and this trend is expected to continue through the forecast period — underpinned by continued strong growth in emerging Asia and a recovery across advanced economies. An anticipated expansion of production and export capacity, particularly for the bulk commodities, will allow for strong volumes growth. For iron ore, mine and infrastructure capacity is forecast to increase markedly, while mine and port expansions on the east coast are expected to support growth in coal exports.

Rural exports are expected to remain at a high level over the forecast period, in line with the outlook for farm production. After recovering to above pre‑drought levels in 2008‑09, farm production is expected to increase by 6 per cent in 2009‑10, followed by more moderate growth over the remainder of the forecast period.

Exports of elaborately transformed manufactures felt the full force of the downturn in global demand associated with the global recession — declining by 21 per cent through the year to the June quarter 2009. In particular, Australian car exports collapsed — reflecting the worldwide decline in demand for motor vehicles. A recovery is now expected as the global economy strengthens, notwithstanding a relatively high exchange rate, with exports of elaborately transformed manufactures forecast to increase by 4 per cent in 2010‑11 and 4½ per cent in 2011‑12, following an expected 3½ per cent fall in 2009‑10. The positive outlook for exports of elaborately transformed manufactures is underpinned by an anticipated bounce‑back in car exports, as demand in key export markets recovers.

For services exports, the recovery is less pronounced given that the sector was less affected by the downturn in global demand. Services exports are forecast to increase by 1½ per cent in 2010‑11 and 6 per cent in 2011‑12, after an expected fall of 2 per cent in 2009‑10 — in part reflecting a decline in the number of foreign students studying at Australian educational institutions.

Import volumes are expected to grow in line with strengthening domestic activity — increasing by 9 per cent in 2010‑11 and 8½ per cent in 2011‑12. Import growth is forecast to be broad‑based, but with a key driver being an expected pickup in capital equipment imports associated with resource sector construction — particularly large LNG (liquefied natural gas) projects.

Box 5: Australia's export performance through the global recession

Australia's export growth was among the highest in the world in 2009, at 0.6 per cent — contributing 0.1 of a percentage point to GDP growth.

In contrast, emerging economies' exports fell by 8.2 per cent in 2009, while advanced economies' exports fell by 11.7 per cent (Chart A).

Chart A: Export performance comparison

Chart A: Export performance comparison

Source: IMF and ABS cat. no. 5206.0.

Australia's export performance in 2009 was stronger than the 5.7 per cent decline expected at the 2009‑10 Budget, when global trade — and in particular, demand for commodities — was anticipated to plunge. The IMF was similarly pessimistic, forecasting a 6.9 per cent fall in Australia's exports for 2009 (at the time of the 2009‑10 Budget).

The 2009‑10 Budget outlook for exports incorporated a significant decline in non‑rural commodity exports for 2009. However, non‑rural commodities performed far better than expected — increasing by 1.4 per cent.

While demand for non‑rural commodities from many of our markets diminished, in line with decreased industrial production, this was offset by an unexpectedly large increase in Chinese demand. China's demand for coal and iron ore increased substantially in 2009 on the back of the Chinese Government's stimulus package.

Rural commodity exports also performed better than expected at the 2009‑10 Budget, with farm production rebounding strongly following a series of drought‑stricken years. Rural commodities were the major contributor to export growth in 2009, increasing by 15.9 per cent.

Terms of trade

Following a small decline in 2009‑10, the terms of trade are expected to surge in 2010‑11 — consistent with the outlook for non‑rural commodity prices. In 2009‑10, the terms of trade are forecast to fall by 3¾ per cent — largely reflecting the impact of the commodity price falls during the global financial crisis. In 2010‑11, the terms of trade are forecast to increase by 14¼ per cent as commodity prices recover (Chart 8).

Chart 8: Terms of trade

Chart 8: Terms of trade

Source: ABS cat. no. 5206.0 and Treasury.

Increasing global demand for commodities has seen significant rises in commodity prices, particularly for iron ore and coal (Chart 9). Spot prices for iron ore have almost trebled over the past year, while spot prices for thermal coal have increased by around 70 per cent.

In 2011‑12, the terms of trade are expected to fall by 3¾ per cent, largely reflecting an anticipated expansion of global non‑rural commodity supply. The sharp run‑up in commodity prices will take the terms of trade to a 60‑year high, generating a substantial supply response. This will increasingly weigh on commodity prices as resources projects ramp up production (Box 6). Nonetheless, by the end of the forecast period, higher commodity prices will see the terms of trade remain around 80 per cent higher than their average in the decade prior to the commodities boom.

Historically, increased supply has seen commodity prices fall from previous peaks. A decline in commodity prices is projected over the medium term as increased supply brings prices down, but there is uncertainty as to the timing and magnitude of these falls.

Import prices are expected to rise slightly in the period ahead, as global excess capacity gradually unwinds.

Chart 9: Bulk commodity prices

Iron ore

Chart 15: Bulk commodity prices - Iron ore

Thermal coal (Newcastle)

Chart 15: Bulk commodity prices - Thermal coal (Newcastle)

Source: Bloomberg, Global Coal and ABARE.

Box 6: The mining boom

The global economic recovery has seen the resumption of Australia's mining boom, which will provide substantial benefits to the Australian economy through higher growth in both output and incomes.

Demand for commodities is expected to strengthen over the forecast period — underpinned by continued strong growth in emerging Asia and a recovery across advanced economies.

The prospect of increased commodity demand is expected to see a significant increase in investment in Australia's resources sector. Total new engineering construction investment is forecast to increase by around 20 per cent a year in both 2010‑11 and 2011‑12 (Chart A).

Chart A: New engineering construction investment

Chart A: New engineering construction investment

Source: ABS cat. no. 5206.0 and Treasury.

Increased activity in the resources sector will boost demand for skilled labour, largely in Western Australia and Queensland, and particularly during the construction phase of major projects.

Underpinned by capacity expansions, Australia's non‑rural commodity export volumes are expected to grow strongly over the forecast period — particularly iron ore and coal. Export income will receive a boost from a higher terms of trade, which are expected to rebound sharply in 2010‑11 on the back of increased commodity prices.

Commodity prices have bounced back markedly following steep declines from late 2008 to early 2009. Spot prices (in US dollar terms) for iron ore have increased by around 190 per cent through the year to April 2010, while thermal coal prices have increased by around 70 per cent over the same period. Recent contract price settlements for bulk commodities have largely reflected spot market trends.

The rebound in the terms of trade is expected to contribute 2¾ percentage points to nominal GDP growth in 2010‑11, following a detraction of ¾ of a percentage point in 2009‑10.

High commodity prices are generating a strong supply response, which should see prices decline over the medium term. Nevertheless, prices are still expected to remain well above historical levels.

Current account balance

The current account deficit (CAD) is expected to narrow from 4¾ per cent of GDP in 2009‑10 to 3¾ per cent in 2010‑11, with the trade balance moving temporarily into surplus. Export incomes are expected to rise substantially in 2010‑11, largely driven by increased commodity prices, but also by higher commodity export volumes. A wider net income deficit is expected to offset the improved trade balance somewhat, with a significant proportion of increased mining profits flowing to overseas investors. The CAD is expected to widen to 5 per cent of GDP in 2011‑12, and the trade balance to move back into deficit, as commodity prices fall slightly and import volumes continue to grow strongly (Chart 10).

The current account deficit reflects the difference between national investment and savings. With investment expected to remain strong as export potential is expanded in the mining sector, the CAD is likely to remain elevated for some time. Budget Statement 4 discusses longer term trends in the CAD.

Chart 10: Current account balance

Chart 10: Current account balance

Source: ABS cat. no. 5206.0 and 5302.0 and Treasury.

Labour market, wages and consumer prices

Labour market

Continued momentum in the labour market is expected to see the unemployment rate fall to around its full employment level over the forecast horizon. Employment is expected to grow by 2¼ per cent through the year to the June quarter 2011 and 2 per cent through the year to the June quarter 2012. The unemployment rate is expected to fall to 5 per cent in the June quarter 2011 and 4¾ per cent in the June quarter 2012.

Australia experienced a relatively shallow downturn during the global recession, with the unemployment rate peaking at 5.8 per cent compared with an OECD average peak of 8.8 per cent. This relatively mild deterioration and subsequent recovery in the labour market has seen Australia record an unemployment rate of just 5.3 per cent in March 2010. With the unemployment rate expected to continue to fall there is a risk that capacity pressures may re‑emerge in certain sectors as the resources sector, both directly and indirectly, places increasing demand pressures on the labour market.

However, the decline in the unemployment rate is expected to be slower than seen in recent quarters as the labour force rapidly expands. This forecast reflects an expectation that the working‑age population will continue to grow strongly and that the participation rate will trend up over the forecast period, reaching 65½ per cent in the June quarter 2011.

Ongoing strength in labour demand will also be met through an adjustment in workers' average hours. During the slowdown businesses generally reduced workers' average hours rather than shedding jobs. As the labour market has recovered, businesses have increased workers' average hours and this is expected to continue, with average hours returning to more normal levels over the course of 2010‑11 (Box 7).

Box 7: The Australian labour market

The Australian labour market has displayed impressive resilience throughout the recent downturn, especially compared with the experience of most other advanced economies.

The trough‑to‑peak rise in the unemployment rate was around 3 percentage points in Canada, the UK and the euro area, 4 percentage points in New Zealand, 6 percentage points in the US and 12 percentage points in Spain. At its peak, the unemployment rate reached double digits in both the US and the euro area.

In contrast, the Australian unemployment rate rose by 1¾ percentage points during the downturn and, at 5.3 per cent in March 2010, is lower than in all major advanced economies except Japan (Chart A). Despite its moderate rise, the Australian unemployment rate has been one of the fastest to fall, decreasing by 0.5 percentage points since its peak in mid‑2009.

A key factor in the strong performance of Australia's labour market has been its flexibility. During the downturn, many employers appear to have reduced staff working hours in preference to job shedding. The result was a substantial fall in average hours. Average hours remain some 3 per cent below their recent peak in July 2008.

Chart A: Unemployment rates

Chart A: Unemployment rates

Source: ABS cat. no. 6202.0 and US Bureau of Labor Statistics, Office for National Statistics, Statistics Canada.

In the 1980s and 1990s recessions, falling average hours accounted for around half the contraction in aggregate hours worked in the Australian economy, with declining employment contributing the other half. In contrast, the fall in aggregate hours worked during the recent downturn has been driven almost entirely by the sharp contraction in average hours (Chart B). This has been accompanied by a strong rise in part‑time employment.

While the decline in average hours worked has resulted in lower employee earnings, it has tempered the rise in unemployment. The fall in aggregate hours worked during the downturn was equivalent to the loss of around 200,000 full‑time jobs. This figure now stands at around 100,000 (as at the March quarter 2010), with aggregate hours having recovered considerably since the lows of mid‑2009.

Chart B: Total hours decomposition

Chart B: Total hours decomposition

Source: ABS cat. no. 6202.0.

As it is typically easier to increase the hours of people already on the payroll than to hire new workers, the labour market can recover more quickly from a fall in average hours than from a substantial rise in unemployment. By limiting job losses, the contraction in hours has significantly reduced the economic and social costs that would have arisen from a more significant rise in unemployment, particularly long‑term unemployment.

Australia will benefit from the relatively small rise seen in longer‑term unemployment, which is likely to limit the extent of skills atrophy stemming from the downturn. In contrast, the US has experienced a rapid surge in the proportion of the labour force that has been jobless for six months or more. Over the past 18 months this proportion has tripled and it is continuing to rise (Chart C).

This is likely to be a considerable drag on the US economic recovery, as those out of work grapple with eroded savings, deteriorating skills and the adverse social and psychological impact of sustained joblessness.

Chart C: Unemployed for 6+ months
as share of labour force

Chart C: Unemployed for 6+ months as share of labour force

Source: ABS cat. no. 6291.0.55.001 and US Bureau of Labor Statistics.


Following recent weakness, wages growth is expected to recover over the forecast period in line with the anticipated strengthening in labour market conditions.

Recent weakness in wages growth reflects the modest downturn in the labour market experienced through late 2008 and much of 2009, with the Wage Price Index growing by just 2.9 per cent through the year to the December quarter 2009. However, the strengthening labour market is expected to cause wages growth to recover, with wages rising by 3¾ per cent through the year to the June quarter 2011 and 4 per cent through the year to the June quarter 2012. There is upside risk to wages growth in industries and regions associated with the resources sector (Chart 11).

Chart 11: Growth in the Wage Price Index

Chart 11: Growth in the Wage Price Index

Source: ABS cat. no. 6345.0.

Consumer prices

Underlying inflation is expected to continue to moderate to 3 per cent through the year to the June quarter 2010 and 2½ per cent through the year to the June quarter of both 2011 and 2012 (Chart 12). The recent moderation reflects the lagged impact of lower import prices, moderating labour costs and the ongoing impact of weak domestic demand over the past year. As economic conditions continue to improve, underlying inflation is expected to stabilise, although there will be upside risks as the economy approaches more normal levels of capacity utilisation.

Headline inflation, at 2.9 per cent through the year to the March quarter 2010, is now running broadly in line with underlying inflation, with the prices of some volatile items (such as automotive fuel and deposit and loan facilities) retracing some of their recent falls. Headline inflation is expected to be 3¼ per cent through the year to the June quarter 2010 (which includes a one‑off ¼ of a percentage point contribution from the increase in the excise and excise‑equivalent customs duty on tobacco products) and 2½ per cent through the year to the June quarter of both 2011 and 2012.

Chart 12: Headline and underlying inflation

Chart 12: Headline and underlying inflation

Note: The underlying inflation measure is the average of the RBA trimmed mean and weighted median.

Source: ABS cat. no. 6401.0, RBA and Treasury.


The strengthening global economy is boosting demand for Australia's non‑rural commodity exports, which is expected to result in a rising terms of trade and strong growth in national income. This, combined with increased business investment, a strengthening in household consumption and rising export volumes, is expected to lead to strong growth in both real and nominal GDP in 2010‑11 and 2011‑12.

Nominal GDP contracted by more than 1 per cent in the year following the Lehman Brothers collapse, the weakest outcome since the early 1960s (Chart 13). Over the same period, the fall in corporate gross operating surplus was also the largest since the 1960s. Labour income also softened as hours worked fell and wages growth eased.

Following this trough, nominal GDP is expected to recover strongly, with above‑trend growth expected in 2010‑11 and 2011‑12. Nominal GDP is forecast to grow by 8½ per cent in 2010‑11, underpinned by a recovery in the real economy together with strong growth in output prices driven by rising non‑rural commodity prices (Chart 14). In 2011‑12, the nominal economy is expected to grow at 5¾ per cent, driven primarily by above‑trend growth in real GDP, supplemented by a more modest contribution from growth in output prices.

The strength in nominal GDP growth is expected to be broadly distributed throughout the economy, encompassing compensation of employees, gross operating surplus and gross mixed income.

As the labour market continues to strengthen, so too will incomes. Compensation of employees is forecast to grow by 7¼ per cent in 2010‑11 as employment growth remains solid and wages growth increases. Gross operating surplus is expected to grow strongly, reflecting rises in non‑rural commodity prices. Gross mixed income, which includes profits of farm and non‑farm unincorporated enterprises, is also forecast to increase strongly.

Chart 13: Nominal GDP growth

Chart 13: Nominal GDP growth

Source: ABS cat. no. 5206.0 and Treasury.

Chart 14: Components of nominal GDP growth

Chart 14: Components of nominal GDP growth

Note: The small discrepancy between nominal GDP and the sum of its components is due to interactions which cannot be attributed to individual components.

Source: ABS cat. no. 5206.0 and Treasury.

Medium‑term projections

The fiscal aggregates in the Budget are underpinned by a set of forward estimates consisting of short‑term economic forecasts and projections based on medium‑term assumptions.

In the 2009‑10 Budget the projection methodology was changed from the usual practice of assuming trend GDP growth. This reflected the expectation that the Australian economy would experience a sustained period of below‑trend growth in the forecast period. A corresponding period of above‑trend growth was assumed in the projections to return the economy to its potential level.

The 2010‑11 Budget forecasts imply that the economy will return to full capacity within the forecast period. The unemployment rate is now expected to have peaked at 5.8 per cent in the September quarter 2009, before continuing to trend down over the forecast period to reach 4¾ per cent in late 2011‑12.

With the economy expected to be back to potential in 2011‑12, it is appropriate to resume the traditional methodology for the projection period, with real GDP growing at its trend rate of growth, currently around 3 per cent per annum (Chart 15).

Chart 15: Real GDP growth over forward estimates period

Chart 15: Real GDP growth over forward estimates period

Source: ABS cat. no. 5206.0 and Treasury.

Trend GDP growth is projected to decline to around 2¾ per cent over the medium term as population ageing generates a gradually falling participation rate.

In the projection period the terms of trade are projected to decline by a total of around 20 per cent over a 15‑year period, settling just below their 2006‑07 level. This reflects an expectation that current levels of commodity prices will not be sustained in the longer term, as increases in supply bring down prices over time.

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