NZ Q2 GDP: Recession

Q2 GDP falls 0.2% q/q

• Recession confirmed.
• Drought, housing, oil, credit factors all at play.
• International financial developments key to future.
• Front loading of OCR cuts to continue.

Phew! It feels odd to have a sense of relief that GDP contracted 0.2%. But we had feared a lot worse (even worse than the 0.5% contraction in GDP, as measured on the expenditure side of the national accounts). It seems the economy only lost a toe, not a foot in Q2.

Combined with the 0.3% contraction in Q1, it is now confirmed that New Zealand was in recession in the first half of 2008. That will surprise few; the writing has been on the wall for some time. Drought, a housing slump, an oil price spike and tight monetary conditions have destroyed growth in many sectors.

Starting with the primary sector, the summer drought that extended into autumn dented agricultural production again, but the contraction was only 0.6%. This was a big surprise to us. We expected the hit to on-farm production to be a lot worse. Dairy output did decline 4.2% and beef fell 7.8%. But we thought the decline in dairy would have been considerably larger and would offset the very large meat (sheep and cattle) kill to reduce food manufacturing. Not so. Food manufacturing rose 2.6%, helping total manufacturing up 1.4%. We still expect the weakness to show up, but now in Q3. This tips our forecast for Q3 GDP into negative territory at -0.1% (from 0.1% previously).

The lack of rain intensified the switch away from relative cheap hydro electricity generation. This lowered value added in the utilities sector, in addition to the overall decrease in the amount of electricity generated. GDP in the electricity, gas and water sector fell 1.6%.

The housing slump worsened in Q2, with residential investment falling 8.2%. This helped pulled down construction GDP by 3.8%. Fallout from the weaker housing market saw the real estate and business services sector contract 1.6%.

Declining house prices, combined with surging petrol prices and high interest rates put the NZ consumer under enormous pressure in Q2. Consequently, private consumption fell 0.2% in the quarter. This is surprisingly robust given the hurdles the NZ consumer has faced in the first half of 2008 (we expected a 0.7% decline). Spending on goods was well down, but largely offset by solid service-related spending. The reduced spending on goods was keenly felt in the retail sector with flow on effects to wholesale, with declines of 1.9% and 1.2% respectively.

There was a large stock build in Q2, but given it was around the same size as the stock build in Q1, the contribution to growth was minimal. We expect the increasing stock levels to put more downward pressure on imports than on domestic production going forward.

Market implications

The better than expected number saw the NZD jump by around 50pts immediately after the release. With NZ now in recession and credit conditions tight we expect the RBNZ to continue front loading interest rate cuts. We retain our forecast of a 50 basis point cut in October.

However, the NZ consumer is holding up better than the RBNZ expected. We estimate the RBNZ had around a 1.0% fall in Q2 consumer spending in the September Monetary Policy Statement. This combined with a very strong rebound in consumer confidence in Q3 will have the RBNZ aware that the downturn in growth may not take the extreme inflation pressure out of the system as quickly as previously hoped. The Quarterly Survey of Business Opinion due for release on 7 October will give a better guide to how much slower growth is easing strains on capacity. For now, front loading - not extra loading - interest rate cuts appears the prudent course of action. That said, all eyes remain on international financial markets

Westpac Institutional Bank
http://www.westpac.com.au

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