Budget Policy Statement

Economic and Fiscal Forecasts

Economic outlook and forecasts

New Zealand's economic performance has been strong since the publication of the Budget Economic and Fiscal Update (BEFU) 2021, reflecting that the economy has been more adaptable and resilient to the COVID-19 pandemic than previously thought. Robust demand throughout the first half of 2021 has catalysed broad-based growth, with stronger-than-expected real production GDP, tax revenues exceeding forecasts, and the unemployment rate dropping to the lowest levels since 2007.

The Delta outbreak that began in August 2021 is expected to weaken this position in the September and December quarters, though we anticipate a relatively swift recovery in activity with only a small degree of scarring as restrictions ease. Accordingly, annual real GDP growth is forecast to peak in 2023, underpinned by growth in consumption and investment that is supported by low unemployment, a strong housing market, and the gradual re-emergence of international tourism.

COVID-19 has equally impacted the supply side, offsetting the disinflationary pressures from activity disruptions. Compounded by persistent domestic demand, supply-side pressures relating to labour/skills shortages, capacity constraints, and international supply-chain disruptions will increase inflationary pressures which saw annual CPI inflation come in above forecast in the September 2021 quarter at 4.9 per cent. Similar inflation is being seen in other advanced economies. In response, the Reserve Bank of New Zealand is expected to continue tightening monetary policy to bring inflation within the 1-3 per cent target band which may also moderate house price growth over the medium term.

This increase in real activity, in combination with higher inflation, translates to nominal GDP being $21.4 billion higher by the year to June 2025 and a cumulative $78.5 billion higher over the forecast period. This is the main driver of the additional $48.6 billion in core Crown tax revenue across the four years to June 2025.

The labour market has been remarkably resilient and is expected to persist in a state of tightness, with firms reporting record-high difficulties in finding skilled labour and near record-high difficulties in finding unskilled labour in the September 2021 quarter. Unemployment is consequently expected to continue to fall to 3.2 per cent in the June 2022 quarter before rising towards 4.1 per cent by the end of the forecast period, and employment is expected to continue to exhibit quarter-on-quarter growth. Both of these will exert upward pressure on wage inflation and labour costs.

The global economic recovery has lost some momentum due to the emergence of Delta and ongoing supply-chain disruptions but the outlook remains more positive than in BEFU 2021 due to vaccinations, policy support, savings drawdowns and the reopening of economic activity. A rise in export prices is forecast to boost the terms of trade in the short term, but declining export prices alongside persistently higher import prices will lead to a lower terms of trade in the medium term compared to BEFU 2021.

The economic forecasts are dependent on some key assumptions. For example, public health restrictions and behavioural responses to COVID-19 are assumed to impact activity to an extent similar to Alert Level 2 until 1 July 2022; the international border is assumed to have a gradual and phased reopening from 1 July 2022; and potential output has been revised lower to account for ongoing disruptions and behavioural shifts related to the pandemic. A significant deviation from these assumptions - on either the upside or the downside - would change the underlying fundamentals of the forecast, as would the realisation of key risks such as the advent of a more communicable or lethal coronavirus.

Table 3 - Summary of the Treasury's Half Year Update economic forecasts

Sources: Stats NZ, the Treasury