Kiwi Economy All Shook Up

Kiwi Economy All Shook Up

- Earthquake and weak demand hinder growth -

GDP fell 0.2% in Q3, which was weaker than expected. This was due to the September 4 earthquake and a slower recovery in demand than expected. Households and businesses remain cautious in their spending and continued weak demand poses a risk to the outlook (and to NZ's sovereign rating). Nonetheless, the fundamentals for medium-term growth are sound: meat and dairy prices are high - which will boost incomes - and the trading partner outlook is strong. We still expect a recovery through 2011 and for rates to rise from Q2 2011, although today's report does signal some downside risk to this outlook.

Facts
- GDP fell by 0.2% in Q3, following (downwardly revised) growth of 0.1% in Q2, to be 1.5% higher over the year. The result was weaker than expected by HSBC and the market (+0.1%).
- Revisions were relatively small, with Q2 year-ended growth only reduced from 1.9% to 1.8%.
- There were declines across most industries in Q3, with particular weakness in construction, manufacturing, agriculture and forestry & fishing.
- The expenditure measure of GDP fell by 0.4% in Q3, driven by a fall in exports and residential building construction.
Household consumption rose by a modest 0.5% in Q3.

Implications
The key question is how much of the weakness in the economy in Q3 was the temporary effect of the Canterbury earthquake, and how much is weaker underlying demand? This is important because the temporary effect of the earthquake tells you little about the economic fundamentals and it is the underlying demand recovery that is important for the outlook.

The national accounts - along with other indicators - suggest that it is a bit of both, though probably more to do with a weaker recovery in demand than the earthquake. RBNZ estimates from the most recent official statement suggest that the earthquake would probably reduce GDP in Q3 by 0.1 percentage points. Other telltale signs of underlying weakness in the national accounts are the only modest growth in household spending (on both consumer goods and housing), despite the likely pull forward due to the October 1 increase in the GST.

Looking ahead, a slower recovery in demand and exchange rate strength in early Q4 - albeit retraced in recent weeks – are likely mean that growth has stayed weak in the closing months of 2010. Household spending in Q4 is likely to be fairly weak, due to some Q3 pull-forward. Business sentiment has also been weaker than in the first half of the year.

We continue to expect that the economy will recover through 2011, driven by the current elevated level of meat and dairy prices, which will support incomes, rebuilding efforts in Canterbury and a boost to service exports from the Rugby World Cup in September/October 2011. Supporting this medium-term view, the labour market is making a gradual recovery, with the trend unemployment rate 0.5 percentage points below its late 2009 peak: although, at 6.4%, it is still well above the natural rate.

These numbers are weaker than was expected and it looks as though growth will continue to be weak in Q4. The fundamentals remain healthy though, and we still expect a recovery in demand through 2011. We continue to expect the RBNZ to resume its tightening cycle in Q2 2011, though today's numbers clearly provide some downside risk to this expectation.

Paul Bloxham, Chief Economist (Australia and New Zealand)
HSBC Global Research
Economics - Data Reactions

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