Households

Household consumption is growing steadily, underpinned by strong employment growth, a fall in petrol prices of around 15 per cent over the past year, and a declining household saving rate. A buoyant housing market has also been supporting consumption through rising household wealth, as well as through expenditure on housing-related items such as furnishings.

Steady growth is expected to continue with household consumption forecast to grow by 3 per cent each year across the forecast period. In 2015‑16, consumption is expected to be supported by low petrol prices and a still strong housing market. Labour market conditions are expected to remain strong and together with low interest rates will continue to sustain consumption growth as support from the housing sector eases in 2016‑17.

A falling household saving rate is also supporting consumption growth. The share of household income saved rose strongly during the period of rapid income growth that accompanied the terms of trade boom, and then more sharply during the global financial crisis. The household saving rate has declined since the recovery from the global financial crisis, providing support to consumption. The household saving rate is expected to decline further at a moderate pace, but remain well above pre‑crisis lows (Chart 3). Uncertainty around the pace of decline in the household saving rate poses a risk to the rate of consumption growth.

Dwelling investment grew by 7.9 per cent in 2014‑15 — the largest growth seen over the past decade, partly driven by a significant shift towards medium‑high density dwellings (Chart 4). Dwelling investment in 2015‑16 has remained strong, supported by low interest rates and an elevated level of work under construction. While the level of investment is expected to remain high, growth is expected to ease to 2 per cent in 2016‑17 and 1 per cent in 2017‑18 as a record number of dwellings reach completion.

Business investment

As the economy transitions from the investment phase of the mining boom to the production phase, the outlook for business investment continues to be dominated by steep falls in mining investment as resource projects are completed. This contraction is expected to lessen by 2017‑18. At the same time the transition to broader‑based sources of growth is expected to drive investment in the non‑mining sectors. Overall, business investment is forecast to fall by 5 per cent in 2016‑17, then remain flat in 2017‑18, driven by mining investment that is forecast to fall by 25½ per cent in 2016‑17 and 14 per cent in 2017‑18.

Conditions are in place for non‑mining investment to pick up. Borrowing costs are low, and domestic demand is forecast to strengthen. There are positive signs of bolstered activity in the service sectors and business surveys are showing improving conditions in the non‑mining sector (Chart 5). Non‑mining capacity utilisation is at its highest level since the global financial crisis (Chart 6).

To date, however, the recovery of non‑mining investment has been slower than expected and leading indicators remain mixed, with some business expectations surveys suggesting the delay may continue into 2016‑17. The ABS Private New Capital Expenditure and Expected Expenditure Survey (CAPEX) and Treasury's business liaison programme suggest that non‑mining businesses have yet to commit to significant new investment plans, which is offsetting some of the more positive indicators.

The pace and timing of a pick up in non‑mining business investment continues to be a key source of uncertainty for the outlook. Along with mixed indicators, a change in the composition of investment creates uncertainty for the forecasts. As mining investment declines and the economy transitions to broader‑based growth, business investment will be underpinned by a greater number of smaller investments, such as investments by small businesses and businesses in the service sectors. The lead times for these kinds of investments are typically shorter than those for large mining projects. This adds to the difficulty in estimating both the timing and scale of the expected pick up in business investment. The sensitivity of the forecasts to a different outlook for business investment is discussed in Statement 7.

Public final demand

The average annual pace of fiscal consolidation in the 2016‑17 Budget across the forward estimates is 0.4 per cent of GDP. This is unchanged from the 2015‑16 MYEFO.

Public final demand, which captures the direct economic impact of consumption and investment across all levels of government, is forecast to grow modestly as most governments remain focused on budget consolidation. As a result, public final demand is forecast to rise by 2¼ per cent in 2016‑17 and 2 per cent 2017‑18.

Exports

Total exports are expected to increase by 6 per cent in 2015‑16, 5 per cent in 2016‑17 and 5½ per cent in 2017‑18. While forecast growth in 2015‑16 is significantly higher than expected at the 2015‑16 MYEFO, forecast growth in 2016‑17, while still strong, is lower than at the 2015‑16 MYEFO. This primarily reflects a higher exchange rate and a weaker outlook for base metal exports.

That said, the resource sector continues to underpin growth in total exports with iron ore and LNG production continuing to ramp up after the investment phase of the mining boom. Mining exports are expected to increase by 7 per cent in 2016‑17 and 7½ per cent in 2017‑18.

In 2015, Australia exported over 760 million tonnes of iron ore, with 625 million tonnes exported to China. This compares with 240 million tonnes of iron ore exported in 2005, with almost 120 million tonnes exported to China. In 2015, China's imports of Australian iron ore increased by around 11 per cent with Australia increasing its share of the Chinese iron ore market.

Over the forecast period iron ore exports are expected to increase by around 16 per cent, while LNG exports are expected to continue to grow strongly, with the Department of Industry, Innovation and Science forecasting exports to triple between 2014‑15 and 2020‑21 (Chart 7).¹

Strong service sector exports have been supported over the past year by a lower exchange rate and rising demand from Asia. Service export volumes are expected to grow by 5 per cent in 2016‑17 and 4½ per cent in 2017‑18 (Chart 8). More than half of service exports are made up of travel services — business, education and tourism travel. Since 2011 visitor arrivals have increased by almost 30 per cent, while Chinese visitors have almost doubled.

A lower Australian dollar since its peak in 2011 and streamlining of student visa policy arrangements have made Australian education exports more attractive over the past two years, with export volumes reaching $18.5 billion in 2015. Asia's economic growth and rising middle class are expected to continue to drive demand for Australia's high quality education sector.

Other service exports have also been growing strongly, albeit from a much lower base. Financial service exports have experienced double‑digit growth for the past five years, and computer and information services exports grew strongly in 2015.

Rural exports are expected to fall in 2016‑17. Beef exports are forecast to fall as a result of strong domestic restocking which is expected to more than offset the modest growth in Australian wheat exports. Export volumes are forecast to improve in 2017‑18 as beef production recovers in response to higher herd numbers and slaughter rates. A higher exchange rate since the 2015‑16 MYEFO is expected to weigh on prices for rural goods in 2016‑17 and 2017‑18.

Imports continue to reflect the transition of the economy to broader‑based growth. Total capital imports are falling as investment in the mining sector winds down, while other imports are rising in line with growth in the broader economy and the appreciation in the Australian dollar since the 2015‑16 MYEFO. Total imports are expected to grow by 2½ per cent in 2016‑17 and 3 per cent in 2017‑18.

The labour market

The transition of the economy towards broader‑based drivers of growth has been most evident in the labour market. Employment grew strongly over the past two and a half years and with GDP growth picking up to 3 per cent over the year to the December quarter of 2015, employment growth has accelerated. In 2015, there was an almost 300,000 increase in employment, the highest in a calendar year since 2007 (Chart 9). The unemployment rate fell by 0.4 percentage points to 5.7 per cent over the year to March 2016.

Employment growth has been supported by moderate wage increases and the transition to more labour‑intensive sectors of the economy. The highest level of employment growth over the past year has been in retail trade and health care and social assistance industries (see Box 4).

While the number of people employed has been rising, the average number of hours worked has been falling. This is in line with an increase in part‑time work in the service sectors and increased participation of females in the workforce, who have higher rates of part‑time employment. The reduction in average hours worked means that total hours worked is spread amongst a larger group of workers, allowing greater employment for a given level of output.

Looking forward, leading indicators such as job advertisements and business survey measures of hiring intentions suggest strong growth in employment will continue. Consistent with the economy's transition, the continuation of strong growth in the labour‑intensive service sectors and moderate wage growth are expected to support a further decline in the unemployment rate.

The unemployment rate is forecast to be 5¾ per cent in the June quarter of 2016 before falling to 5½ per cent by the June quarter of 2017. The unemployment rate peaked earlier than forecast at the 2015‑16 MYEFO and is now at a lower level over the forecast period.

The participation rate is expected to remain around recent levels over the forward estimates. The improvement in labour market conditions is expected to continue to encourage job seekers back into the labour force to resume their search for work. Growth in the more flexible service sectors may also increase female participation. These positive effects on workforce participation will be somewhat offset by the ongoing effect of population ageing.

The current strength of the labour market is also being reflected in the opportunities provided to and taken up by Australia's youth. The youth unemployment rate has declined significantly to 12.0 per cent in March 2016, down 2.5 percentage points since its recent peak of 14.5 per cent in November 2014. It is now at its lowest level since July 2013.

Moderate wage growth is supporting employment and facilitating the economy's transition. Wage growth has been low by historical standards in both the public and private sectors. The Wage Price Index, which measures changes over time in wages and salaries and is unaffected by compositional change in employment, grew by 2.2 per cent through the year to the December quarter of 2015. Wage growth is expected to remain constrained and has been revised down since the 2015‑16 MYEFO. It is now forecast to grow by 2¼ per cent through the year to the June quarter of 2016 and 2½ per cent through the year to the June quarter of 2017.

Consumer prices grew by 1.3 per cent over the year to the March quarter of 2016. This weak result was driven primarily by falls in petrol prices, competition in the retail sector and moderate wage growth. Moderate wage growth is expected to continue to weigh on price growth over the forecast period, which has been downgraded since the 2015‑16 MYEFO. CPI inflation is forecast to be 1¼ per cent through the year to the June quarter of 2016 and 2 per cent through the year to the June quarter of 2017. A strengthening economy and increases in tobacco excise are expected to support an increase in inflation to 2¼ per cent through the year to the June quarter of 2018.

Outlook for nominal GDP

Nominal GDP growth is forecast to be a little lower than at the 2015‑16 MYEFO, reflecting weaker forecast inflation in 2015‑16 and slightly lower forecast growth in real GDP in 2016‑17. The level of nominal GDP is expected to be lower than at the 2015‑16 MYEFO over the forward estimates, reflecting weaker wages and inflation. This has contributed to lower tax receipts, excluding new policy, of $13.5 billion over the four years to 2018‑19 compared with the 2015‑16 MYEFO (see Statement 4: Revenue).

Low commodity prices continue to weigh on Australia's terms of trade but some renewed strength since the beginning of 2016 has led to some upward revisions to the forecast terms of trade since the 2015‑16 MYEFO. The terms of trade are now forecast to fall by 8¾ per cent in 2015‑16, before increasing by 1¼ per cent in 2016‑17 compared with falls of 10½ per cent and 2¼ per cent respectively at the 2015‑16 MYEFO.

Continuing the approach taken at the 2015‑16 Budget, the price of oil and key commodity export prices that underpin the forecasts are based on a recent average.

Iron ore prices have risen recently in US dollar terms. The iron ore price underpinning the forecasts is $US55 per tonne Free on Board (FOB), compared with $US39 per tonne FOB at the 2015‑16 MYEFO. Metallurgical coal is also a key input into steel production. The metallurgical coal price is $US91 per tonne FOB compared with $US73 per tonne at the 2015‑16 MYEFO. The price of thermal coal remains unchanged in US dollar terms since the 2015‑16 MYEFO.

Although prices for some key commodities have increased in US dollar terms since the 2015‑16 MYEFO, the overall impact on nominal GDP has been partly offset by an appreciation in the Australian dollar. Australia's key commodities are traded in US dollars and a higher exchange rate has reduced the price exporters receive in Australian dollar terms. The exchange rate is now assumed to be 77 cents against the US dollar compared with 72 cents at the 2015‑16 MYEFO.

A key risk to the nominal GDP forecast is the volatility and uncertainty around movements in commodity prices. The inherent uncertainty around both supply and demand factors means the outlook for the price of iron ore is subject to considerable risk.

The impact of iron ore prices being US$10 per tonne lower/higher, based on the sensitivity analysis presented in Statement 7 is set out in Table 3. A US$10 per tonne reduction/increase in the iron ore price results in just over a $6 billion reduction/increase in nominal GDP in 2016‑17. These illustrative impacts differ from those presented in the 2015‑16 Budget due to a more comprehensive analysis presented in this year's Statement 7. In particular, the sensitivity analysis now assumes that export commodity prices fall/rise over the course of a year rather than an immediate movement. The effect of this is to reduce the impact in the first year of the analysis. The effect in the second year is in line with the earlier sensitivity analysis. For purposes of comparison an immediate fall/rise in the iron ore price would have a direct effect in the first year of around an $11 billion reduction/increase in nominal GDP in that year.

Table 3: Sensitivity analysis of iron ore price movements(a)

	US$45/tonne FOB(b) spot price			US$65/tonne FOB spot price
	2016‑17(c)	2017‑18		2016‑17(c)	2017‑18
Nominal GDP ($billion)	-6.1	-13.4		6.1	13.4
Tax Receipts ($billion)	-1.4	-3.9		1.4	3.9

(a) Key aggregates are shown relative to the 2016‑17 Budget iron ore price forecast of US$55/tonne and based on an exchange rate assumption of 77 US cents.

(b) FOB is the free‑on‑board price which excludes freight costs.

(c) This is the price by the end of 2016‑17.

Source: Treasury.

Medium‑term projections

The fiscal aggregates in the Budget are underpinned by economic forecasts for the budget year and the subsequent financial year and then by economic projections for the following two financial years. These projections are not forecasts. Rather they are based on a medium‑term methodology and some key assumptions.

Crucially, the medium‑term projection methodology assumes that spare capacity in the economy is absorbed over five years following the forecast period. The sensitivity of the projections to a different adjustment period is analysed in Statement 7.

As the spare capacity is absorbed, labour market variables, including employment and the participation rate, converge to their long‑run trend levels. To absorb the spare capacity in the economy, from 2018‑19 real GDP is projected to grow faster than potential at 3 per cent. By the end of 2022‑23 spare capacity is absorbed and real GDP grows at its potential rate thereafter.

Potential GDP is estimated based on an analysis of underlying trends for population, productivity and participation. Australia's potential GDP growth rate is estimated to be 2¾ per cent over the next few years. The unemployment rate is projected to converge back to 5 per cent over the medium term consistent with Treasury's estimate of the non‑accelerating inflation rate of unemployment (NAIRU). Inflation is projected to be 2½ per cent, consistent with the Reserve Bank of Australia's medium‑term target band. The terms of trade is projected to remain flat at around its 2005 level from 2019‑20.

In the 2015‑16 MYEFO, the medium‑term projections were updated in response to new data on population and participation. An update in response to changes in the data to account for developments in commodity markets has now been completed resulting in changes to the terms of trade outlook in the medium term (see Box 6).

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1 Resources and Energy Quarterly March 2016, http://www.industry.gov.au/Office-of-the-Chief-Economist/Publications/Documents/req/REQ-March-2016.pdf