Budget 09: Households to tighten their belts

The forecast is that consumer spending will continue to fall. Photo / Herald on Sunday

The Treasury's economic forecasts make grim reading for any business chasing the consumer's discretionary dollar.

Household spending, which makes up more than 60 per cent of demand in the economy and which has shrunk over the past year, is forecast to keep on falling and more sharply - by 1.3 per cent over the year ahead and 1.5 per cent the following year, before flatlining the year after that.

This is a much bleaker outlook than the consensus of private sector forecasters, but the Treasury had the advantage of knowing the Government's intentions regarding tax cuts (scrapped) and spending (belt tightened).

In effect it is assuming that households will rein in their spending until they are no longer spending more than they earn, a process that will take years.

The unemployment rate climbs from 5 per cent now to a peak of 8 per cent in the second half of next year, and the Treasury expects a further 12 per cent drop in house prices.

The outlook for economic growth overall is weaker than even the downside scenario in the December forecasts, shrinking by 1.7 per cent over the year to next March, followed by a "hesitant" 1.8 per cent recovery the following year. On a quarterly basis growth does not return until the December quarter this year, after seven consecutive quarters of contraction.

The level of economic activity does not return to where it was in late 2007 until the middle of 2011.

On the international front the context of the Budget is the deepest slump since World War II and an expectation that New Zealand's trading partners will contract by 2.5 per cent, when they normally grow 3 to 4 per cent.

The Treasury acknowledges some recent signs that at least the rate of decline in the global economy is reducing amid signs of stabilisation in global financial markets, but it sees this more as a necessary condition of the upswing it is forecasting rather than grounds for believing it will be more vigorous.

The forecasts revise down the terms of trade - a measure of relative prices of the sorts of things the country exports compared with what it imports - sharply to the sorts of levels prevailing in the late 1990s.

Finance Minister Bill English said the recession had exposed structural weaknesses and imbalances in the economy which had been built up for 10 years, in particular growth reliant on excessive spending by households and the Government, while the export sector struggled.

ANZ National Bank economist Khoon Goh said if there was a big theme underpinning the Treasury's economic forecasts, it was an unwinding of those structural imbalances.

It would help to reduce the current account deficit from 8.6 per cent of gross domestic product now to 5.5 per cent within a couple of years. "We concur with this," he said.

Deutsche Bank chief economist Darren Gibbs said after being much too optimistic last year the Treasury's economic projections now erred on the side of being too conservative.

"We think there is plenty of scope for the size of deficits and debt to prove less than the Treasury projects."

Since mid-April when the forecasts were completed, some forward-looking indicators such as consumer and business sentiment had improved, as had economic and financial indicators in New Zealand's major trading partners, Gibbs said.

Bank of New Zealand head of research Stephen Toplis said it was heartening that the Treasury's forecasts for the next three years were conservative. Any surprises were likely to be on the pleasant side.

The BNZ does not expect household spending to drop as steeply over the next couple of years as the Treasury does, or house prices to drop 12 per cent.

"If we do have a concern with Treasury's growth profile it is that its forecasts for 2013 to 2016 assume growth approaching 4 per cent per annum. Those forecasts are key to the eventual reduction in net debt."