Budget 2017: Economic growth seen peaking at 3.8pc in 2019

Finance Minister Steven Joyce, escorted by Prime Minister Bill English on his way to read his Budget 2017. Photo / Mark Mitchell

New Zealand's economic growth is tipped to peak in 2019, boosted by ongoing population growth, investment, and a new family incomes package announced in Finance Minister Steven Joyce's maiden budget. Growth, however, then tapers off as net migration subsides, construction growth eases and rising interest rates begin to bite.

While the economy expanded less than expected this year as exports, residential investment and business investment grew at a slower pace than anticipated, "growth is forecast to accelerate to a peak of 3.8 per cent in 2019 as investment growth gains momentum and private consumption is supported by fiscal stimulus associated with the family incomes package," Treasury said.

The $2 billion family incomes package - which will come into play in April 2018 - is expected to benefit about 1.3 million families in New Zealand by, on average, $26 per week. Treasury expects households to spend the majority of the boost to their incomes. Overall it is "estimated to have a modest positive long-run impact on GDP," it said.

The Treasury also expects residential investment growth to pick up again "after a temporary pause in 2017" as rapid population growth and low interest rates fuel demand for housing, although it will ease from 2019 onwards as supply increases to meet demand, it said. House prices lift 7.8 per cent in the year to June 2018 after increasing 5.1 per cent in the current year, according to Treasury forecasts. It also expects business investment to pick up, further supporting economic growth.

It is expecting real GDP growth of 3.1 per cent in the year to June versus a prior forecast of 3.6 per cent. It now expects the economy to grow 3.5 per cent in the year to June 2018 and 3.8 per cent in the following year versus a prior forecast of 3.5 per cent and 2.9 per cent. Growth now eases to 2.9 per cent in the year to June 2020 and 2.4 per cent in the year to June 2021. Prior forecasts were for 2.4 per cent and 2.3 per cent growth respectively.

Population growth continues to support the economy in the short-term. According to Treasury, net migration has continued to outpace its expectations, with annual net migration rising to 71,900 in the year to March 2017. While net migration is now expected to remain higher for longer, Treasury is tipping it to peak at 72,500 in mid-2017 before beginning to ease. Overall, it expects net migration to add 212,000 people over the next four-and-a-half years, around 67,000 more people than it previously forecast.

The high inflow of people mans that unemployment is forecast to remain flat at around 5 per cent over the year ahead, as rapid labour force growth is balanced by robust employment growth. However, it will ease to 4.3 per cent in 2020, the forecasts show.

It notes that employment growth is stronger than it forecast in the half year economic and fiscal update but the labour force is also forecast to increase at a faster rate "meaning spare capacity in the economy is not used up as quickly as previously anticipated." The result is a higher unemployment rate and weaker wage growth over the period.

Tepid wage growth has largely kept inflation under wraps. While Treasury noted that inflation surpassed 2 per cent in early 2017 this was largely driven by temporary price movements. However, it is forecast at 2.1 per cent in the year to June 2019, as spare capacity is absorbed and capacity pressures build, in part due to stimulus from family incomes package, it said. This will lead to a gradual lift in interest rates.

It forecasts the 90-day bank bill - widely viewed as a proxy for the official cash rate - to remain at 2 per cent in the year to June 2018 before gradually raising to 3.9 per cent by the year to June 2021. While the end point is similar to its December forecast, it now sees rates at 2.7 in the year to June 2019 and 3.4 per cent in the year to June 2020 versus a prior forecast of 2.3 per cent and 3.2 per cent.

Earlier this month, the central bank left interest rates on hold at a record low 1.75 per cent and continued to forecast that they will remain unchanged until mid-2019.

Treasury also said the country's terms of trade remains higher than it expected in the December forecasts given a recovery in export prices and a slide in import prices. However, it expects it to now remain flat, tipping import prices to remain "relatively muted," largely due to a gradual increase in oil prices, and for export prices to "increase gradually" over the forecast period.

The high terms of trade is one factor underpinning the New Zealand dollar. While it has fallen to around 76.1 on a trade-weighed-index basis, Treasury said it expects it to remain around current levels as the economy has continued to expand at a solid pace, interest rates are high compared to other advanced economies and the terms of trade remain high compared to historic averages. The forecasts show it reaching 76.9 in 2019 before easing to 74.7 in 2021. Its December forecast had it reaching 72.6 in the year to 2021.

Treasury underscored that "the economic outlook is subject to a range of risks and uncertainties, with global risks skewed to the downside while domestic risks are more balanced."

It pointed to potential disruption in global trade, uncertainty around US fiscal policy, financial stability in China, as well as the Australian economy. Domestically it signalled that uncertainty around net migration add to uncertainty around the economic outlook as does household consumption, saving and the housing market.