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Earthquake knocks confidence

The negative economic implications from February’s tragic earthquake were apparent in business and consumer confidence surveys released this month and in our contacts with business.  These developments were, for the most part, foreshadowed in the February issue of Economic Indicators and do not significantly alter our preliminary assessment of the impact of the 22 February Christchurch earthquake.  Our first Special Topic summarises the main messages from our March round of business talks. 

The calamitous 11 March earthquake in Japan has however led us to revisit some of our assumptions around trading partner growth and the performance of the external sector.  Trade with Japan is likely to be negatively impacted in the short-term but the reconstruction programme is expected to be positive for New Zealand’s export prices.  There are also implications for energy markets.  Our second Special Topic covers the economic implications of the disaster in more depth. 

Output per person falls…

From a solid start early last year, the economy shed momentum through the middle of the year, narrowly avoiding a return to recession in the final quarter.  Real GDP rose 0.2% in the December quarter after a 0.2% fall the previous quarter and a 0.1% increase in the June quarter.  Little surprise then, that on a per capita basis, real GDP fell in each of the last three quarters of 2010 (Figure 1). 

Figure 1 - Real GDP per capita
Figure 1 - Real GDP per capita   .
Source:  Statistics NZ

Figure 1 also shows that output per person in New Zealand has fallen in 15 of the last 21 quarters, and that New Zealand suffered from a similar spell of prolonged poor performance in the late 1980s, although the decline in the earlier period is larger. 

Relative to our Half Year Update, most of the weakness came from consumer spending and falling levels of residential investment.  In contrast to domestic weakness, external drivers were more positive than forecast. 

…but output in current prices rises on higher GST…

GDP in current prices, the primary driver of overall tax revenue, was boosted by the rise in GST, up 2.6% in the December quarter, slightly weaker than expected.  It appears that businesses have not increased overall prices to the extent we anticipated, reflecting the challenging retail sales environment.  This view is supported by lower than expected GST revenue in the January year to date, which relates largely to activity for the year ending December, where the main cause of the shortfall has been lower prices rather than lower sales volumes. 

…and higher terms of trade. 

A rising terms of trade is also boosting nominal GDP.  The merchandise terms of trade rose to its highest level in 37 years in December, and looks likely to rise further (Figure 2). How long the run-up in export commodity prices continues is uncertain, and as Figure 2 shows, periods of sharply rising prices are typically followed by sharp falls.

Figure 2 - Terms of trade and commodity prices
Figure 2 - Terms of trade and commodity prices   .
Source:  Statistics NZ, ASB

In the dairy market there are signs that prices may be close to their peak, although commodity markets have been volatile in the weeks following the large earthquake in Japan and may have been a factor in the 8% decline in prices at Fonterra’s 15 March global DairyTrade auction.  However, the fall may also be signalling that a rebalancing in the dairy market is underway.  Supply is increasing in the US and Europe and dairy futures prices in the NZX market have fallen.  Nonetheless, demand for other export commodities remains strong, helping the ASB NZ commodity price index to rise 1.5% over March and 10% since December.  Higher commodity import prices, particularly for oil, are tempering the terms of trade impact both directly and indirectly by constraining consumer demand for our exports.

Reinsurance inflows affect the Balance of Payments

Strong trading partner growth and high commodity prices are also helping keep the current account deficit close to decade lows, although recent movements have been dominated by reinsurance inflows arising from September’s earthquake.  The current account recorded a deficit of 2.3% of GDP in December, down from the previously published 3.1% in September (Figure 3).  September’s figure was revised down to 2.2% as the size of reinsurance inflows was revised up to $3.6 billion from $1.7 billion. 

Figure 3 - Balance of Payments
Figure 3 - Balance of Payments    .
Source:  Statistics NZ

The annual goods surplus rose to $3.4 billion (1.7% of GDP) in December, the largest surplus since late 2001, but recent data point to a decline in the March quarter.  February’s merchandise trade data showed that the annual trade surplus narrowed to $758 million from a high of $1.4 billion in November 2010.  

Balance of Payments data for the March 2011 quarter, to be released 22 June, will include all known reinsurance claims arising from the 22 February quake up to the time of publication.  It is impossible to know how large the initial estimate will be, but we expect reinsurance inflows in the March quarter to eventually reach $6 billion, large enough to push the annual current balance into surplus for the first time in 37 years.  Foreign earthquake aid inflows are expected to provide further support.  

The assets underpinning the reinsurance inflows have been a factor in reducing net international liabilities to 81.7% of GDP from 86.5% a year ago. But this impact is temporary and will reverse as insurance claims are settled. 

Financial cost of earthquake remains tentative

Our assessment of the financial costs of the earthquakes remains tentative.  It remains too early to be able to assess the financial costs of damage caused by the February earthquake with any confidence.  The information we have received to date has been very partial and has not provided strong grounds to revise our estimate of the combined cost of the September and February earthquakes from $15 billion.

Business and consumer confidence slump

Headline business confidence in the National Bank’s Business Outlook survey swung from a net 37% expecting the economy to improve to a net 9% expecting the economy to deteriorate.  The proportion of companies expecting to do better over the year ahead fell to 15% from 36% in February.  Firms in the agriculture sector remained positive about the outlook in contrast to retail firms where the majority of respondents were negative about the outlook.  Firms were also less optimistic about the outlook for profits, exports, the labour market and investment.  

Consumer confidence also deteriorated in March according to both the Westpac-McDermott Miller and ANZ-Roy Morgan surveys, implying that the recent trend of subdued consumer spending will continue (Figure 4). 

Figure 4 - Consumer confidence and consumer spending
Figure 4 - Consumer confidence and consumer spending   .
Source:  Treasury, Westpac, ANZ, Statistics NZ

Other data this month reinforce this subdued trend: residential building consents fell 9.7% in February to their lowest level in two years; household credit grew just 0.1% in February and 1.5% from the same month a year ago; and both petrol and food prices continued to rise, restricting households’ discretionary spending. 

Labour productivity trend remains weak

Labour productivity grew 3.7% in the March 2010 year driven by a 4.3% fall in labour inputs and a smaller decline (-0.8%) in real output of the measured sector (which excludes

hard-to-measure industries such as government administration & defence, health & community services, education).  For the March 2006 to March 2010 period labour inputs fell 3.0% and real output rose 0.5%, resulting in average labour productivity growth of a little less than 1% per year, well below the average of 2.0% since 1978. 

Looking ahead, labour productivity growth will likely fall in the March 2011 year.  Economy-wide data for the 2010 calendar year shows a 2% increase in paid hours and a 0.8% rise in output, which implies labour productivity fell.  With output expected to contract in the March 2011 quarter, labour productivity growth since March 2006 could slow to an average of 0.5% or less per year.  In addition, the destruction of a sizeable proportion of New Zealand’s capital stock is likely to have an initial negative impact on labour productivity. This may be offset as rebuilding begins.

Risks to trading partner growth have increased

Positive growth has continued amongst our main trading partners, albeit with increased risks arising from intensified Middle East violence and the Japanese disaster. While the markets have focused on these events, the US has seen some improvement in the labour market, the UK has had a new budget and the Euro sovereign debt crisis has returned to the news.

US and UK recovering gradually...

We see growth continuing in the US, although there are significant risks to the outlook. On the plus side, December quarter growth was an annualised 3.1% and March PMIs continued to be strong; manufacturing could be the significant driver of growth this year. The US labour market continues to improve gradually, with the unemployment rate in February sitting at 8.9%. However, the risks to growth are significant. The US housing market remains very weak with prices and sales numbers very low. We do not envisage a significant economic recovery until the current trend reverses. The other main risk to growth we see in the near-term is the end of the Fed’s quantitative easing programme, which is unlikely to be extended beyond June. There are concerns that the US recovery will not be sustained without this additional stimulus.

March saw a new budget in the UK, with the changes largely fiscally neutral after the major cuts were announced in last year’s budget. The budget contained a cut in corporate tax rates and a lowering of petrol taxes, the latter mainly in an effort to make spending cuts more palatable. Despite the significant budget changes over the past two years, the government still expects to be in deficit for the next five years, albeit at a much lower rate than the 11% of GDP seen in 2009/10. Forecast growth rates were revised down for the UK, in part due to the lower contribution from the government, but also due to the December quarter weather shock in 2010. Inflation continues to be a concern, with the latest annual rate being 4.4%. While a portion of this is the recent VAT increase, there are pressures from growing energy, food and other retail prices. This has led to the likelihood of the Bank of England hiking rates to a higher level than previously expected over the next year.

Figure 5 - GDP growth in Australia, UK and US
Figure 5 - GDP growth in Australia, UK and US   .
Source:  DataStream

... with Australia leading the pack

Australia is continuing to be the leader of the advanced economies, with record terms of trade meaning prospects are good for continued strong growth. GDP increased 0.7% in the December quarter. The household sector remains cautious, partly due to rising energy prices, higher interest rates and debt consolidation. The strong labour market, with the unemployment rate at 5.0%, poses an upside risk for household consumption. The recent Japanese disaster will likely have a short-term detrimental effect on exports through disruption, but in the medium term should be positive for commodity exports. (See the second special topic for a discussion of the economic impacts of the Japanese earthquake).

Continuing unrest in the Middle East...

The events in the Middle East and Japan have dominated world markets during March. The continuing conflicts, particularly in Libya, have pushed oil prices higher, further pressuring advanced economies’ recovery. Oil prices did decrease temporarily after the Japanese disaster due to a drop in refinery demand, but recovered as focus returned to the violent conflicts in Libya. The real concern is if the violence moves to more significant producers of oil in the Middle East, which could severely hamper production.

... and Euro issues to the fore again

Euro sovereign debt issues returned to the fore during March, with Greece, Spain and Portugal all receiving credit downgrades. Portugal’s Prime Minister resigned after his party’s budget was rejected by opposition parties for going too far on spending cuts and tax increases. This has led to more uncertainty, and will likely lead to a bailout. Discussions took place during the month among Euro area countries on setting up a bailout fund. However, due to some disagreements surrounding contributions and timing, the final form it may take is unclear.

China is still seen as the growth driver for the world. The government released its five-year economic plan, which included targeting a lower, more sustainable, rate of growth. China is also looking to rebalance towards more domestic demand, mainly through higher consumption instead of exports and investment. Inflation continues to be high, in particular food prices, although the People’s Bank of China has continued to respond by further tightening bank reserve requirement ratios in an effort to curb credit growth. This appears to be working somewhat, with the housing market beginning to show signs of cooling.

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