Risks to the outlook

The risks around the domestic economy are weighted to the downside, particularly if dry conditions persist and seasonal conditions do not return to average in 2007-08 as assumed.

Australia continues to benefit from strong demand for our commodity exports. This surge in demand requires a large adjustment within the economy, with significant increases in the demand for labour and capital in the mining and related sectors. This adjustment will take time and so far has progressed smoothly. Wages and other input prices have increased to attract the required resources. To date, these sector-specific input cost increases have not spilled over into other sectors. However, there is a risk that if labour and capital do not move to the fast-growing sectors of the economy, output growth could be constrained and there may be more significant upwards pressure on prices.

Rising house prices in the early part of this decade contributed to rising household debt and increased the sensitivity of households to adverse labour market outcomes and interest rates. Moreover, while housing market conditions have improved in recent months, there remains considerable uncertainty around the pace and extent of household balance sheet consolidation. It is possible that consumption and dwelling investment growth will slow more than expected in response to recent higher interest rates and the expected easing in employment growth.

While high petrol prices have constrained consumption spending, the surge in other key commodity prices has significantly boosted investment and domestic incomes. The surge in mining investment and exploration, in Australia and elsewhere, is expected to place downward pressure on commodity prices. Commodity prices are inherently difficult to predict, and if they were to remain high or increase further this would provide an additional boost to domestic income and production.

Forecasts for world growth have been revised up from Budget, although a number of downside risks remain. The potential for a larger-than-anticipated housing-led slowdown in output in the United States represents a significant downside risk to world activity. Whilst oil prices have moderated in recent months, they remain high and could retrace their recent falls. A disorderly adjustment of world saving and investment imbalances continues to be a risk to the global economy as such an outcome could substantially affect exchange rates and world growth.