Drought fears keep market reaction to strong GDP muted

Thursday 21st March 2013

The impact of the worst drought in New Zealand's North Island for almost seven decades kept investors nervous after government figures showed the economy grew at its fastest quarterly pace in three years in the last three months of last year.

The New Zealand dollar gained about half a US cent, recently trading at 82.59 US cents, while swap rates rose about 5 basis points, with the two-year swap rate recently at 2.895 percent.

Those gains came after figures showed gross domestic product expanded 1.5 percent in the three months ended Dec. 31, almost twice the 0.8 percent pace predicted by the Reserve Bank, and the fastest quarterly pace since December 2009.

"The market is very concerned about drought - people overseas don't really understand drought and are very cautious," said Dominick Stephens, chief economist at Westpac Banking.

The Reserve Bank trimmed 0.2 to 0.3 of a percentage point from its growth forecasts in the first half of 2013 due to the drought, and the potential cost of the arid conditions has been put as high as $2 billion. The bank doesn't expect to raise interest rates until next year, with tepid inflation and a gradual economic recovery.

Traders are betting central bank governor Graeme Wheeler will add 21 basis points to the official cash rate over the coming 12 months, according to the Overnight Index Swap curve. They had priced in 17 basis points of increases yesterday.

Westpac's Stephens said the better than expected growth should make up for any downside built into the Reserve Bank's forecasts based on the drought.

"Basically the worst possible estimate of drought is fully covered by the GDP surprise," he said.

Darren Gibbs, chief economist at Deutsche Bank New Zealand, said the economic growth may bring the central bank's view on the future interest rate track closer to market expectations, though it won't have any obvious influence until the labour market improves and inflationary pressures start coming to bear.

"I'm very happy to see the economic growth in Q4, but I don't think too many people are re-writing their forecasts," Gibbs said.

The growth in December was underpinned by a 3.2 percent increase in primary sector activity to the sector's highest level since the series began in June 1987.

Stephens said the increased activity was part of the $30 billion Canterbury rebuild, which will have a "massive impact" on the economy, and came after a slowdown through the middle of last year.

Construction grew 1.8 percent in the December quarter, its fifth straight gain, on the strength of heavy and civil engineering. The sector has grown 6.1 percent annually, though is still below it speak in June 2010.

BusinessDesk.co.nz

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