The economy will grow faster this year than forecast even in July, driving unemployment lower and inflation higher, according to today’s Mid-Year Economic Forecast released by Treasurer Wayne Swan.

However, the stronger dollar has knocked more than $8b off revenue projections for the next four years, as part of an overall revenue fall of $9.7b, including a $3.1b reduction in revenue from the early stages of the MRRT.

Treasury has upgraded Australia’s expected GDP growth in 2010-11 from 3% in July to 3.25%, with unemployment forecast to fall further to 4.75%, rather than 5% forecast in the Pre-Election Economic and Fiscal Forecast, and falls further to 4.5% in 2011-12. Forecasts and projects for 2011-12 and the subsequent two years remain the same, but inflation is expected to rise to 3% in 2011-12, rather than the previously forecast 2.75% (“the risks are on the upside,” Treasury remarks in the document).

Despite the fall in unemployment, however, Treasury forecasts the wage price index to grow at the same rate as previously forecast, 3.75% this year and 4% next.

The impact on revenue means an $800m rise in this year’s Budget deficit to $41.5b, a $1.9b rise in 2011-12, a small fall in the forecast surplus in 2012-13 from $3.5b to $3.1b, and another fall in 2013-14 to $3.3b.

The higher growth will be sourced almost entirely from our terms of trade: MYEFO forecasts yet another weakening of construction activity, further downgrading the Budget forecast of private dwelling investment from 7.5% this year to 4.5% (in 2009, it had been forecast to hit 11.5%) and another fall from 4% growth in 2011-12 to 3%. Treasury tries to put a positive gloss on the dwelling figures, noting:

The number of finance commitments for the construction of new dwellings is down nearly 28 per cent through the year, while trend growth in building approvals has fallen in each of the past six months. Nonetheless, the outlook is for dwelling investment to continue growing, consistent with interest rates currently at around neutral levels, a positive employment outlook and a pipeline of construction activity arising from the strength of population growth in recent years.

Unlike construction, however, total business investment is forecast to grow even more strongly, however, from a Budget forecast of 7% to 8% this year.

The mooted spending cuts floated in the media haven’t materialised, with the Government only adding relatively small cuts to the savings outlined in its election commitments, but remaining well within its self-imposed 2% real spending growth target. Public spending is forecast to grow 1.5% this year, fall by 1.1% next year (driven by the end of stimulus programs), and grow 1% in 2012-13 and 1.6% the following year.