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Monthly Economic Indicators

Analysis

Earthquake derails subdued recovery …

This issue of Economic Indicators has been brought forward to give our preliminary assessment of the impact of the 22 February Christchurch earthquake on the economy. The assessment is tentative as there are many uncertainties and our analysis will be reviewed prior to the 2011 Budget. The earthquake has had a large cost in both human and economic terms and this report considers only the latter.

The economy was much weaker in 2010 than we had previously expected and – as we began to prepare our 2011 Budget forecasts prior to the 22 February earthquake – it was our view that the outlook for 2011 was also weaker than in the Half Year Update. The earthquake has now set the recovery back further.

… as economy was already looking weaker

In the January Indicators we detailed the surprise contraction in economic activity in the September quarter 2010 and said we expected that weakness to continue into the final quarter of the year. It is now apparent from data released in the past month that activity in the final quarter of 2010 was probably weaker than we expected a month ago. That weakness is concentrated in domestic demand and is in contrast with the stimulus being received by the primary sector from high world prices for commodities. However, this income does not appear to be flowing through to business and household spending as farmers reduce debt.

High commodity prices lift business confidence before the earthquake

In the February National Bank Business Outlook, which predated the earthquake, there was a lift in general confidence and in firms’ assessment of their own activity. In both cases the lift was chiefly the result of a brighter outlook for agriculture.

While the recovery from the early-season La Nina drought contributed to the lift in sentiment, higher global prices for agricultural and other export commodities were also a major factor. In the final quarter of 2010, New Zealand’s terms of trade (the ratio of goods export prices to import prices) passed their 2008 peak and rose to their highest level since the early 1970s (Figure 1).

Export commodity prices continued to increase in early 2011 with the ANZ world price index lifting 2.7% in February, its sixth consecutive increase and up 26% from a year ago. Dairy auction prices have increased 33% since November in US dollars. In recognition of the higher price level, Fonterra revised its forecast payout for the current season from $7.30-7.40/kg of milk solids to $7.90-8.00/kg.

Figure 1 – Overseas merchandise terms of trade
Figure 1 – Overseas merchandise terms of trade.
Source: Statistics NZ

Higher commodity prices are already flowing through to other parts of the economy with producer prices and retail food prices starting to increase at a faster pace, putting pressure on both businesses’ and households’ expenditure.

Firms not expanding employment …

Despite the strength in commodity prices, firms showed limited expansion in labour inputs in the December quarter. According to the Quarterly Employment Survey (which excludes agriculture), total weekly paid hours fell 0.2% in the December quarter, but were still up 2.0% from a year ago following two large increases earlier in the year.

These results were reinforced by the Household Labour Force Survey which showed that the total number of people employed in the December quarter was down 0.5% from September. However, the fall was concentrated in part-time employment (-2.8%), with a slight increase in full-time employment (+0.3%). As a result, total actual hours worked in the quarter increased slightly (+0.2%) as those in employment worked slightly longer hours.

… but wage growth starting to turn up

Some of the weakness in the demand for labour was offset by a slight pick-up in wage growth. The quality-adjusted Labour Cost Index ticked up from a 1.6% annual increase in September to 1.7% in December, with the public sector showing relative restraint at 1.4%. Growth in average hourly earnings in the Quarterly Employment Survey rose from 1.3% in September to 1.9% in December. Higher wage growth and longer working weeks offset the decline in employment so that total gross earnings were up 0.6% in the December quarter and 4.0% for the year. Source deductions for the six months to December were slightly above our Half Year Update forecast.

Household demand still soft

Despite the offsetting impact of higher wage growth and lower employment, households remain cautious in their spending. Core retail sales volumes (excluding vehicles and fuel) were flat for the second quarter in a row in December; total sales volumes (including vehicles and fuel) declined 0.4% for the second successive quarter. Sales were weak even allowing for a fall in vehicle and durables sales following the increase in GST at the start of the quarter. Our initial analysis points to slightly negative real private consumption in the December quarter and higher food and fuel prices will constrain household demand in the current quarter. The February earthquake occurred against this background of weaker than expected domestic demand.

The earthquake caused substantial damage …

It is still too early to estimate with confidence the financial cost of the damage caused by the February earthquake, but it is likely to be 2 to 3 times the estimated NZ$5 billion cost of the September event. Allowing for some double counting for cases where prior damage has been compounded, we estimate the combined financial cost of the two earthquakes at around NZ$15 billion. There is considerable uncertainty associated with this estimate (and its components) which is best described as a working assumption rounded to the nearest $5 billion.

Table 1: Estimate of financial costs of earthquakes
NZ$ bn Residential Commercial Infrastructure Total
Sep-10 3.25 0.75 1.0 5.0
Feb-11 6.0 3.0 3.0 12.0
Total* 9.0 3.0 3.0 15.0

* Totals do not sum to avoid double counting of damage

Source: Treasury estimates

… and has had a large economic impact

The financial costs of the earthquake are largely covered by insurance or central and local government, but the extent of the damage is an important factor influencing the economic impact of the earthquake. To estimate that, we distinguished the following phases: the negative impact of the earthquake on economic activity in the Canterbury region (which accounts for about 15% of the New Zealand economy); the delay in the previously planned rebuild from the September earthquake; and the positive impact as the rebuilding phase gets underway to replace buildings and belongings destroyed in the earthquake. There are also considerations of longer-term impacts, such as reduced productive capacity in the economy as a result of the loss of capital.

September earthquake recovery delayed

Before the 22 February earthquake, the boost to economic activity stemming from the recovery associated with the September earthquake was looking slower than we incorporated in the Half Year Update, which showed some pick-up in activity in the December quarter followed by a further boost in the March quarter. Much of this was related to demolition activity, although some rebuilding work was anticipated in the March quarter. In reality, substantial rebuilding work was not scheduled to occur until late March and so the earliest significant boost was likely to come in the June quarter. Consequently, we were already revising down our growth estimate for the March 2011 quarter.

Greater caution by households and firms

In addition, households and firms appear to be exhibiting greater caution in their spending and investment decisions. Taken together, this meant that our view on growth at the end of 2010 and first half of 2011 was already looking considerably weaker than incorporated in the Half Year Update prior to the February earthquake. This is reflected in our view that it is a line call whether December quarter real GDP contracted. Our estimate is for no change in real GDP in the December quarter (down from 0.9% growth in the Half Year Update). This result would leave real GDP in the December 2010 quarter just 0.5% higher than the same quarter a year earlier.

In terms of the bigger picture, whether growth in the December quarter was slightly negative or flat is only significant for the near-term economic outlook to the extent that negative data releases can weigh on confidence. The more important story is that 2010 was fairly weak as a result of increased household saving, negative events such as September’s earthquake and storms, two droughts that bookended the calendar year, and a further hit to confidence from sovereign debt concerns overseas.

However, as discussed above, there were tentative signs of recovery taking hold in early 2011 prior to the February earthquake, with growth also expected to be boosted by rebuilding after the September earthquake and the hosting of the Rugby World Cup. As a result, we were expecting real GDP in the December 2011 quarter to be around 3.5% higher than a year earlier prior to the recent earthquake.

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