Video transcript: New Zealand economic outlook (March 2018)

Transcript for a video of a presentation about the economic outlook for New Zealand filmed at the 2018 Audit New Zealand client update.

Please note: this presentation was filmed in March 2018 before the release of the latest Budget. 

Title: New Zealand economic outlook, Phillip Mellor, Team leader, Forecasting, The Treasury

Phillip Mellor

Good afternoon, ladies and gentlemen, and thank you very much for the warm welcome. Hopefully, I’ll live up to expectations.

I’m going to give you a bit of an update on the economic outlook for New Zealand, so, the presentation that I’m doing today is based on The Treasury’s Half-Year Economic and Fiscal Outlook update that we produced just before Christmas. I’ll try and give you a bit of a sense of where we’re going on the Budget forecast that we’re working on at the moment as I go along in the presentation.

I’m just going to start with giving you a bit of an overview of what we’re seeing, and then I’m gonna step through some of the key drivers behind the growth outlook that we see and then just do a quick wrap-up on some of the fiscal outlook.

The overall economic outlook for New Zealand is pretty positive. We’re expecting real GDP growth to average just a little under three percent over the next five years, and that’s been underpinned by a range of growth factors. So, particularly, migration – the population growth – which has been particularly strong over the last couple of years; the effect that low interest rates are having on the economy, particularly that sort of stimulatory monetary policy coming through; some of the stimulatory fiscal policy that’s about to start coming through as well. And, finally, despite a lot of the noise that you hear in the news and stuff, the international outlook is actually looking pretty positive as well. So, that’s playing through particularly into our trade channels.

So, all up that gives us a pretty good outlook for nominal GDP and that’s really what drives tax revenues and flows through into our favourable fiscal outlook. That strong outlook for growth flows into our labour market as well so we’re expecting the labour market to steadily tighten with unemployment falling towards four percent, and a consequent sort of pick-up in wage growth over that time as well.

Inflation is probably the puzzle at the moment, inflation has remained pretty subdued despite our reasonably strong growth, the very stimulatory monetary policy we’ve had. And we’re expecting interest rates to begin rising but not for a little while yet, so, probably not from until 2019 onwards.

So, that’s kind of what we’re seeing at the half-year update. What we’re seeing now is pretty much the same; we’re only a few months down the track. Probably the big difference is a bit of a timing shift, so, GDP growth is looking a little bit weaker in the short term and that’s really just some of the sort of the weird weather that we’ve had over the last few months flowing through into agricultural production and just causing a bit of a slow-down there. But we expect some of that growth to be picked up over the longer term. So, on balance the outlook’s not looking too different in our Budget forecast at the moment.

So, just starting to step through some of those growth drivers – population growth is very high at the moment, it’s a little bit over two percent which is getting up there in terms of a post-World War Two average, and it’s really been driven by those migration flows. So, migration peaked at about 72,000 last year, still hovering up there, the numbers came out this morning at 69,000. So, very high levels of migration and that’s coming through both sides of the equation really. We’re seeing really strong net inflows of non-New Zealand citizens coming here to work and to study, and at the same time we’ve got the traditionally very large outflows of New Zealand citizens, particularly going to Australia, has basically come into about zero at the moment. So, between those two things it’s really driving that migration flow. We’re expecting migration flows to continue easing from here over the forecast period but remain well above their long-run average and all up that adds close to 200,000 people to our forecasts. So, obviously that’s coming through on both the demand side of the economy, which I’ll talk about in a second, as well as the supply side which also feeds a little bit into some of the expenditure, the fiscal expenditure side as well.

So, one of those places where population-led demand is showing up is in household consumption, so household consumption has been growing at a pretty rapid rate in aggregate, but probably the distinction there is it’s remained pretty subdued on a per capita basis; so, the average household has not really been increasing its consumption that rapidly, roughly in line with the post-financial crisis average. But because we’re getting all these extra households coming through who want to buy goods and services that’s bolstering our overall consumption. And similar government fiscal stimulus is starting to come through. Well, we’re expecting it to come through in this area as well. So, the Families Package that was announced by the Labour-led government is gonna kick in from the middle of this year and that flows through as a boost to incomes, particularly for lower income households, which we expect to flow through into consumption.

One of the big risks that we’ve been flagging here for a while now is around the response that households might take to rising interest rates. So, if you think most newer households or newer homeowners won’t have faced a sustained rate increase cycle, so that’s one of the risks that we’re flagging, and we’ll be watching with close interest as if and when interest rates start to rise.

Just talking a little bit about housing, so housing construction, which we call residential investment in the system of national accounts, that’s been growing at a fairly rapid pace, part of that is related to the Christchurch rebuild which is now starting to taper off. But in general, the level of the construction activity out there is pretty high, but what we’re seeing now is increasingly running into capacity constraints and that in that sector, so, things like shortages of skilled labour, some of the finance and credit constraints, but just a general infrastructure constraint. We hear lots of stories about, you know, how difficult it is to drive a concrete truck around Auckland, for example, and that just slows down the whole pipeline of work.

So, that leaves us to having a pretty, I guess, neutral outlook for construction over the next year or two. But we’re expecting some of the government policies that have been announced, particularly KiwiBuild, to start alleviating some of those capacity constraints and let that pace of housing construction to pick up again and start trying to address some of the housing shortfalls. All up, the KiwiBuild programme is assumed to add about $5 billion over the next few years and that’s roughly recycling the capital injection of that $2 million about twice. That’s all I wanted to say there.

The labour market. So, with pretty strong growth in the economy that flows through into demand for labour and we’re expecting that to really outstrip growth in the labour force, plus on the supply side of the labour market. Labour supply has actually been growing really strongly, it’s getting where that migration is showing up in terms of the supply side of the economy but not just that but participation rates, so, the rate of how many people are wanting to enter the labour force has been really high as well. So, between those two it’s creating a huge pool of I guess potential workers out there, but our economy has been able to absorb that and as a result we’re expecting unemployment to sort of steadily decline from four-and-a-half now to around four percent. The inverse of that is really starting to build up into wage pressures, so wage pressures have been pretty subdued since the financial crisis and we’re expecting as the labour market tightens as we’re really starting to squeeze out as much of that unemployed workforce as we can into the labour force, that’s gonna start putting some pressure on wages. The other factor that we’re expecting to see in wage growth is the Government’s policy around lifting the minimum wage to $20 per hour in 2021, and so that adds a bit to the wage of inflation pressures as well.

So, although we’ve got pretty strong wage inflation expected, general consumer inflation is expected to remain pretty subdued, so it’s tracking sort of around one-and-a-half percent at the moment, and we’re expecting a little bit of volatility in the shorter term, there’s a few of the Government’s policies coming in that will dampen down inflation, so, things like the fees-free tertiary education, cheaper doctor’s visits, that will all lay on inflation. But with the economy growing pretty strongly we’re expecting capacity pressures to build in the economy and that will start to translate in some inflationary pressures, and we’re expecting interest rates to start rising from, sort of, early next year, the next forecast; that’s one thing that’s looking a bit different in the Budget forecast, it’s probably been pushed out a little bit probably more towards the end of 2019 now.

Just on the international outlook. So, despite what you might read on the news and on the Twitter feeds, the international outlook is actually reasonably good from a growth perspective. So, growth amongst some of our key trading partners, we’re expecting that to be above trend over the next few years, particularly in places like the US, Euro area, Japan, and Australia. Probably a notable exception on that list is the UK where there’s obviously some Brexit issues still to be worked through. Growth in China – we’re expecting that to slow a little bit from, say, six-and-a-half to six percent, something like that. On the whole, we think that’s a favourable shift for New Zealand as they shift more into consumption-led growth, and New Zealand’s exports are more geared towards consumption than, say, Australia’s preference for hard commodities like iron ore.

So, that translates into a pretty healthy outlook for demand for our exports, as well as our terms of trade. And terms of trade is the ratio of export prices to import prices, so we’re expecting that to remain at pretty high levels over the next few years. I don’t have enough history on that chart but essentially, we’re at 40-year highs for our terms of trade. The prices that we’re getting there are pretty healthy and that flows through into both into the nominal economy and then into taxes.

Although our base case for the outlook is pretty good, there are some pretty notable risks in the international outlook and I just wanted to highlight a couple of them. One is around what we call monetary policy normalisations, so, some of the big economies around the world have been printing money, have really low interest rates and how they unwind that is gonna be pretty important, particularly the market reaction to that. We saw a bit of a flutter on the equity markets a couple of weeks ago, just some of that noise coming through as, it’s kind of a weird reaction, when there’s good news it’s bad news, or something like that anyway. Equity markets are a funny beast. So, it’s one thing that we’re looking at. The other one that’s probably even more relevant or, I guess, more timely is some of the debates around free trade, trade liberalisation, so we’re seeing a lot of stuff coming out of the US now. We don’t expect the recent US stuff to have a large direct impact on New Zealand but if that sort of escalates further and spreads into some of the exports that we specialise a bit more in, that could start to have some material effects.

All in all, our pretty positive economic outlook translates into reasonably positive fiscal outlook, so, activity in the economy generates taxes and that’s looking pretty healthy. And then on the other side of the equation the system of sort of fixed nominal baselines in allowances is capping expenditures. So, as a result, we’re expecting the operating surplus, operating balance before gains and losses, to post early rising surpluses over the forecast period, although we acknowledge there’s probably quite a lot of cost pressures out there that might start to eat into that.

So, just to sum up then, the economic outlook for New Zealand is looking pretty positive, driven by some of those key factors that I’ve talked about – migration-led population growth, the stimulatory effect of low interest rates, the stimulatory effect of fiscal policy, and the positive international outlook – and that’s translating through into our rising operating surpluses over the forecast period.

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