WEEKEND ECONOMIST: Testing the GDP waters

Australia's fourth quarter GDP figures should show we were faring well before the floods. Meanwhile, New Zealand's economy is set to take a big knock from Tuesday's tragic earthquake.

The National Accounts, to be released on Wednesday, will provide an update on the growth pulse of the Australian economy. Our forecast for fourth quarter GDP growth is 0.8 per cent/quarter, or 2.8 per cent/year. That follows the official initial estimate for the third quarter of 0.2 per cent/quarter, or 2.7 per cent/year, and precedes disruptions to production by devastating floods in January.

Our positive view on fourth quarter growth has been supported by recent quarterly partials (CAPEX and construction work done). Also, labour data has been relatively strong, with hours worked increasing by 0.8 per cent/quarter, 3.2 per cent/year in the fourth quarter.

Consumer spending (0.5 per cent) and business investment (3.5 per cent) are expected to drive growth in the fourth quarter, while we anticipate that housing and public spending were flat.

Meanwhile, net exports and inventories are forecast to be neutral in the fourth quarter. That's in contrast to a modest subtraction in the third quarter, which was the major driver of disappointing GDP growth.

More specifically, the National Accounts are expected to show:

-- Domestic demand (0.8 per cent): We're forecasting a slight strengthening of domestic demand growth, to 0.8 per cent in the fourth quarter up from 0.6 per cent in the third quarter. That's driven by stronger business investment growth and an improvement in housing, such that private demand growth accelerates to 1.1 per cent from 0.6 per cent in the third quarter.

-- Household consumption (0.5 per cent): Consumer spending is ticking over at a modest pace it would appear. Rising household incomes, on the back of a strong labour market, are providing consumers with the ability to spend but, for now, they remain restrained and selective in their expenditures. That's apparent from real retail sales, which were -0.3 per cent in the fourth quarter, following 0.5 per cent in the third quarter. However it's not all negative news, motor vehicle sales bounced back, 1 per cent in the fourth quarter, following -5 per cent in the third quarter. We expect other non retail spending to also have held up well.

-- Dwelling construction (flat): Residential construction, after being a drag in the third quarter, -1.8 per cent, is likely to be flat in the fourth quarter. Construction work data reported private new residential construction -1.5 per cent, offset by private renovation work 2.0 per cent.

-- New business investment (3.5 per cent): There was an acceleration of business investment spending in the fourth quarter it would appear. We're forecasting 3.5 per cent following 2.0 per cent. There was strength in non-mining investment, with equipment spending rising by 6.1 per cent, and we're forecasting intellectual property products to increase by 1 per cent. Infrastructure work is surging, 10.2 per cent, more than offsetting a drop in non-residential building work -9.2 per cent.

-- Public spending (flat): The boost to activity from public demand (now 24 per cent of the economy) has run its course for now, with the winding down of the federal government's stimulus package. The CWD survey reported public construction -2.8 per cent in the fourth quarter after -2.6 per cent in the third quarter, with the completion of various school building projects. We expect the fourth quarter fall in total public investment to be a little less than that and that a modest rise in public consumption (which accounts for 74 per cent of total public demand) to provide an offset.

-- Net exports (0.1ppts): We expect net exports to be broadly neutral in the fourth quarter, adding just 0.1ppt, following a -0.4ppt subtraction in the third quarter. Export volumes are forecast to rebound after disruptions to production triggered a -2.4 per cent in the third quarter.

-- Private non-farm inventories (-0.8 per cent, 0.0ppt contribution): We expect a further run-down of inventories, by both the mining sector (to meet export orders) and retailers (given patchy sales). We're forecasting the decline in inventories in the fourth quarter to be equal to that in the third quarter, hence a neutral impact on quarterly GDP growth.

New Zealand

Tuesday’s tragic earthquake is devastating for the people of Christchurch, and has touched the lives of all New Zealanders. For a city already coping with the aftermath of last September’s 7.1 magnitude earthquake and the thousands of aftershocks that have followed, this is heart-rending. The February 22 earthquake measured lower on the Richter Scale than the September shake, at 6.1. However, as Tuesday’s quake was centred closer to the city centre and was shallower, the ground beneath Christchurch actually shook more violently this time. The intense shaking combined with the lunch-hour timing of Tuesday’s quake resulted in a horrific human toll.

In time attention will turn to the economic cost of the latest quake. It is too early to place a meaningful value on the damage, other than to say that it will in all likelihood be far greater than the damage from last September, currently reckoned at $NZ5 billion-plus. Economic activity will take a severe knock in the short term.

We estimate that disruptions such as school closures and reduced retail spending following last September’s quake shaved at least 0.3 per cent off national GDP growth. The disruption this time will be more severe and longer lasting. And this latest crisis is doubly damaging because one of the key pillars of growth in 2011 has been knocked from under us. We had expected Canterbury reconstruction activity to begin in earnest around now, but this is now likely to be delayed until late 2011, as the assessments and planning begin afresh. Our forecasts will be subject to revision over coming weeks as more information becomes available, but at this stage we have trimmed 1.5 percentage points from our 2011 GDP growth forecast, which now stands at 1.7 per cent.

From the Reserve Bank of New Zealand’s point of view, the most acute risk is a loss of business and consumer confidence. We now think there is a good chance that the RBNZ will cut the official cash rate by 50 basis points to 2.50 per cent at its the March 10 Monetary Policy Statement. This is a difficult call, and market opinions regarding the RBNZ’s likely course of action vary. In this kind of situation we must put ourselves in the Governor's shoes, given what we know about the RBNZ's decision-making process and the information we have so far about the scale of this disaster. Our judgement is that the Governor will err on the side of shoring up confidence and easing the burden on an economy whose short-term growth prospects have been stunted. To be effective, the cut would need to be timely and meaningful in size (i.e. more than 25bps). Regardless of whether the RBNZ delivers a cut on March 10, we no longer expect any hikes in the cash rate this year.

In time reconstruction activity will provide a large boost to Christchurch and New Zealand GDP growth. We have pencilled in the greater part of this activity for 2012 and 2013. As the Canterbury reconstruction effort draws on the nation’s scarce (and damaged) resources, inflationary pressures are likely to develop.

While the RBNZ will be at pains to give growth a chance, eventually interest rate hikes could be required. We are now forecasting a steep series of hikes through 2012 and 2013, taking the cash rate to 5.25 per cent by June 2013.

It is inevitable that the government accounts will deteriorate as a consequence of the quake. The state-owned Earthquake Commission (EQC), which is liable for the first $100,000 of damage to insured residential properties plus $20,000 for household contents claims, has $6.6 billion in reserves and reinsurance contracts before it starts to draw on government guarantees. The government is also liable for repairing its own buildings and infrastructure in Christchurch, and will probably cover much of the cost of restoring local infrastructure. Fiscal revenues will drop with the short-term hole in economic activity, and there will be costs associated with health and welfare spending, ACC claims, and housing and accommodation benefits. However, Standard & Poor's have affirmed New Zealand’s AA rating, noting "the government has sufficient flexibility to absorb additional fiscal costs without a negative impact on its creditworthiness.” Markets responded calmly, with government bond yields falling after the quake.

Andrew Hanlan is a senior economist at Westpac

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