Thursday, March 24, 2011

NZ growth: not as bad as it looks

New Zealand GDP data for the December quarter released today continues the trend of flat GDP results over the last nine months.

The best news about December’s small positive result is we don’t have to endure newspaper headlines tomorrow morning proclaiming the return of recession. The thing is GDP data doesn’t give us the full picture about what’s going on in the economy at the moment, and it’s not all bad news.

The fact is households are repaying debt and that’s a good thing. According to Reserve Bank of New Zealand data total household debt as a proportion of total household disposable income is falling. After peaking at 157% just prior to the onset of the Great Recession, the ratio is now down to 153%. It would be good if it kept falling. This ratio was around 60% in 1990, so there’s plenty of downside potential.

Of course while households are retiring debt, growth in consumption will remain hard work. While that makes the going tough for the retail sector now, less indebted households bodes well for more sustainable medium-term growth and reduced external vulnerabilities.

A similar phenomenon is playing out in the business (agriculture) community. You might wonder why strong exports over the last couple of years haven’t been reflected in stronger GDP growth. That’s because recent strong export values have been largely (but not entirely) a price rather than a volume phenomenon. Real GDP measures increases in the volume of activity, not the value.

Higher export prices are reflected in stronger growth in nominal GDP and, ultimately, profits of businesses. But as with households, the farming sector is currently focusing on debt retirement. Again, that’s not a bad thing, but it does keep growth soft in the meantime.

Today’s data did show growth in the right areas. Export volumes are expanding and, despite business sector deleveraging, business investment is growing. That’s a necessary precursor to a strong productive sector export oriented recovery.

I think the going remains tough for GDP growth in the next few months. We had been looking for the Rugby World Cup and the rebuild following the first Canterbury earthquake to provide some impetus to growth later this year. The RWC will still add around 0.3% to GDP in the second half of 2011, but following the February 22nd earthquake, we have shifted the Canterbury rebuild impact out to 2012.

So we see a modest building of momentum through the course of 2011, with annual GDP growth of just under 2% by the December 2011 quarter. That then accelerates sharply over 2012, largely on the back of the Canterbury rebuilding efforts, with growth around 4% by the December 2012 quarter.

We need to interpret this 2012 growth with a little caution. Much of this activity is simply the rebuilding of houses and infrastructure that was already there. Sure it provides incomes for builders and contractors while it’s happening, but it is not going to increase the productive capacity of the New Zealand economy. It simply gets us back to where we were.

This has implications for monetary policy. Our previous story of an early gradual and hopefully pre-emptive move on monetary policy has changed on the back of growth that proved to be lower over the last 9-months than even our miserly forecasts predicted, the series of Canterbury earthquakes which has implications for the pattern of growth over the next few quarter. And of course monetary condition were eased recently so the OCR is now at a lower starting point.

The upshot is that we now see a more aggressive track for interest rate hikes, starting with a 50bp increase in December this year. We expect this to be the start of a series of 50bp increases that will see the OCR up to 4.5% by the third quarter of 2012.

We had previously thought 4.5% might be enough (the “new normal” neutral OCR) at least in terms of an initial target to get to. It’s too early (and indeed too complex!) to make a judgement on whether that remains the case. Much will depend on whether the RWC and the Canterbury rebuilding provide a kick-start to a broader recovery or whether households are still repaying debt. And we won’t know that till we get there.