Mild recovery was underway before quake

24 March 2011 For Immediate Release

New Zealand Q4 GDP rises

Mild recovery was underway before quake

GDP rose by a modest 0.2% in Q4 2010, to be 0.8% higher over the year. New Zealand thus avoided technical recession and was staging a mild recovery before February's quake. The earthquake is expected to have significantly disrupted economic activity in Q1/Q2. The focus must now shift to signs of recovery, as repair and reconstruction plans commence. We also need to watch the 85% of the economy largely unaffected by the quake and being boosted by lower rates and rising commodity prices. We suspect upside risks to inflation mean the RBNZ needs to begin to reverse policy sooner rather than later. Next hike Q4. Facts - GDP rose by 0.2% in Q4 2010, a little more than consensus and HSBC's expectation (+0.1%). Over 2010 growth was +0.8% (versus consensus +0.7%).

- Over the year, GDP growth was supported by strong contributions from forestry, fishing and mining (+5.9%) and construction (+4.9%).

- Expenditure components suggest that residential building fell sharply in 2010 - in line with building consents - falling 5.5% over 2010. Household consumption was weak, rising by 1.3%, while investment rose strongly through the year (13.6%). Gross fixed capital formation rose by 4.8% in Q4 2010, with the main driver being transport equipment, also reflected in rising imports.

Real gross national disposable income rose by 4.6% over 2010, its fastest rate since late 2008.

Implications The Q4 GDP numbers for New Zealand are even more of an historical artefact than usual. Since then, the late February earthquake disrupted growth substantially in the Canterbury New Zealand region, the RBNZ has cut rates back to emergency levels, 2.5%, and plans are beginning to be formed to repair and reconstruct Canterbury.

What the numbers do confirm is that there was a little bit more momentum going into 2011 than was expected. Growth was largely driven by a recovery in investment, mainly transport equipment, which is consistent with rising commodity prices and a farm sector investing in capacity. It's also worth recalling that the RBNZ's March official statement relayed that their January round of business visits suggested conditions were 'surprisingly strong'. It seems the economy was on the path to recovery going into February. This was somewhat derailed by the late-February earthquake in Canterbury.

Looking forward, as policymakers and markets must do, the economy will be boosted by significant spending to repair and reconstruct Canterbury. Estimates suggest that around NZD15 billion worth of the capital stock (equivalent to around 8% of nominal GDP) was destroyed by the earthquake. Spending will be supported by payouts from the Earthquake Commission, with some of these already having been made prior to the February quake, in response to last September's quake. The May budget is also likely to contain some discretionary stimulus measures to support Canterbury, though the extent of net additional spending for the economy as a whole may be limited by significant levels of public debt and an underlying need for continued fiscal consolidation to protect New Zealand's sovereign rating.

With interest rates now back at emergency levels for the whole economy it will also be important to watch developments in the 85% of the economy largely unaffected by the earthquake. The economy will also be further boosted over coming quarters by the Rugby World Cup in September/October and the rising terms of trade.

The risk is that with rates back at emergency levels and global inflation, oil and food prices all rising, inflation holds up above the RBNZ's comfort zone. To contain inflationary pressures the RBNZ will need to begin to lift rates when recovery is underway. We expect that they will be cautious about lifting rates, given the weakness of New Zealand Q4 GDP rises

the economy late last year following the attempt to begin to move rates towards normal earlier in 2010 and the uncertainty involved in assessing the earthquake recovery effects. With inflation already above the RBNZ's comfort zone, as a result of tax changes last year, and inflation expectations only a little below 3%, which is the top end of the RBNZ's target band, the risk is that the RBNZ could get behind the curve.

Bottom Line The Q4 GDP numbers suggest the Kiwi economy was already starting to recover prior to the February earthquake. This was supported by RBNZ liaison with firms in January. The quake will clearly reduce activity in Q1 and Q2 2011, but we expect it to be boosted by reconstruction and repair in H2. Inflation is also expected to hold up at uncomfortably high levels, prompting the RBNZ to need to lift rates.

We still expect the next rate rise in Q4.

Paul Bloxham, Chief Economist (Australia and New Zealand) HSBC Global Research

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