Economy starts descent to a soft landing

Treasury forecasts paint a picture of an economy which has begun its descent towards a soft landing.

The 4.8 per cent growth in gross domestic product recorded over calendar 2004 (mainly in the first half year) is likely to be as good as it gets.

Growth is forecast to slow to 2.3 per cent in the year to March 2006 and 2.5 per cent the year after. These forecasts are in line with the consensus among private-sector forecasters.

The slowdown reflects the combined effects of a high dollar and high interest rates, the continuing decline in net immigration, slower growth among New Zealand's trading partners and a less favourable ratio of export to import prices.

One result will be fewer new jobs. Employment growth should slow from a brisk 3.6 per cent in the year just past to 0.6 per cent in two years' time.

But because the growth in the workforce is expected to slow as well, due to a dwindling net inflow of migrants, the unemployment rate is expected to remain below 4 per cent for the next year before rising gently to about 4.5 per cent by 2009.

Wage growth, always a laggard in the economic cycle, will continue to rise towards a peak of 4.7 per cent late next year before easing back towards 3.5 per cent.

But the growth in household incomes (the combined effect of more jobs and higher wages) is peaking about now, the Treasury believes, and will halve over the year ahead.

Growth in consumer spending will accordingly slow from 5.7 per cent over the past year to 2.7 per cent in the year to March 2007.

That is despite the stimulus from the Working for Families package which was announced in last year's Budget but much of which kicks in this year.

Labour productivity is expected to increase over the next two years, to about 2 per cent per annum, as recent entrants to the labour force become more productive and as businesses boost investment.

Business investment rose a strong 17.9 per cent last year, well outstripping its average 7.7 per cent growth over the previous four years. Firms responded to robust demand, rising profits, increasing difficulty finding labour and lower prices for imported capital goods because of the high dollar.

The housing market is expected to cool, however, under the chilling influence of a weaker labour market, less net immigration and the delayed impact of higher interest rates.

Residential rents, Treasury notes, have not kept pace with construction costs or house prices, reducing the return from investment in rental properties. And rapid growth in the number of apartments, combined with fewer overseas students, has increased the risk of oversupply in that part of the market.

Treasury neglects to add that planned changes to the depreciation regime, making for slower depreciation on buildings, might at the margin have a negative effect on the attractiveness of residential property investment as well.

Exports are expected to continue to grow, in volume terms, but more slowly due to the delayed impact of the high exchange rate and slower world growth.

Treasury's forecasts assume only a gradual decline in the exchange rate. They have the dollar remaining at its March quarter average of around 70 on the trade-weighted index through the June and September quarters, before declining by about 16 per cent over the following two years.

"However, there is considerable uncertainty surrounding the timing and extent of any depreciation in the exchange rate." Particularly now, Treasury says, given uncertainty about the path of the United States dollar.

Should the kiwi's decline prove more rapid than expected, the slowdown in economic growth would be a gentler and briefer one, but inflation and interest rates would be higher.

Treasury's central scenario has inflation remaining with the Reserve Bank's 1 to 3 per cent target band for the next two years - but only just.

It expects interest rates to remain around their present levels for another year to "lean against" inflation pressures before easing back 1.2 percentage points by 2009.

As currency hedges which locked in less challenging exchange rates expire, exporting firms face a potentially abrupt transition to higher exchange rates.

And the buffer of high world prices for agricultural export commodities is expected to decline in the second half of this year.

The current account deficit is expected to widen further, to 7 per cent of GDP by late next year or early 2007, before narrowing only slightly to 6 per cent by 2009.

Slowing down

* Employment growth should slow from 3.6 per cent to about 0.6 per cent in two years.

* The unemployment rate is expected to remain below 4 per cent for the next year. Wage growth will continue to rise towards a peak of 4.7 per cent late next year before easing back towards 3.5 per cent.

* Growth in consumer spending is expected to slow from 5.7 per cent to 2.7 per cent.