Monday, March 11, 2013

NZ GDP growth, the drought and the RBNZ

As drought continues to grip a large part of the country, I have shaved a bit off my GDP growth in the March and June quarters of this year.  That reflects a number of factors including reduced milk production and food processing as well as lower value-add in electricity generation.  I’m now expecting 0.6% growth in the March 2013 quarter (previously 0.7%) and 0.5% in the June quarter (0.7%). 

Lower milk production in this latter part of the season follows a strong first half of the season.  Indeed full-year production could still come in just ahead of last year.  That’s no consolation to farmers though whose profitability will be hit by the combination of drought and the persistently firm exchange rate, although rising international dairy prices may assist to some degree.  Dairy prices were up 10% at the most recent auction last week.  Longer term the impact of lower stock levels as farmers reduce stock numbers will be felt through lower production. 

The Reserve Bank may not have yet factored the drought into the GDP forecasts they will release with their March Monetary Policy Statement this week, but I expect they will at least highlight it as a risk.  More generally recent activity data has probably surprised to the upside.  Also, the Bank will likely boost their estimate of growth in the last quarter of 2012 upwards from their initial estimate of +0.4% q/q to something closer to our +0.8%.  That data is released next week with the late surge expected to result in annual growth of 2.2% for calendar 2012.  My forecast for calendar 2013 is 2.6%.

Other factors the Bank will be digesting are the continued strength in the exchange rate (the Trade Weighted Exchange Rate Index has appreciated around 4% since their last set of projections), the continued gradual improvement in global economic conditions, the lower starting point for its inflation projections (the December quarter CPI was lower than expected), the weak labour market and continued signs of strength in the residential housing market.

Collectively those factors are expected to add up to “no change” in monetary conditions this week and likely little change to the Bank’s forward interest rate projections indicating a tightening in conditions from early 2014.  That will be based on a cyclical strengthening in economic growth over the course of the year reflecting a strong rebound in construction activity. Given my predilection to believe there is less spare capacity in the economy, I’ve still got the first tightening pencilled in for December.