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Deutsche Bank: GDP (June Quarter)

Data Flash (New Zealand) Gross Domestic Product (June Quarter)

Key Points GDP (production based) fell by 0.7% qoq in the June quarter - weaker than the average market expectation of 0.4%. The RBNZ's August Monetary Policy Statement was based on an estimate of -0.2%.

Downward revisions of, in total, 0.6% to the previous three quarters meant that the year-on-year growth rate was recorded as 4.5%, 0.8% below market expectations.

The GDP data reinforced the AUD related weakness in the NZD seen prior to the release. The Kiwi weakened 30 bps to 0.4070 immediately after the data, but recovered somewhat during the remainder of the day. There was no reaction in the fixed interest markets.

In terms of production sectors, an early close to the dairy season resulted in reduced activity for agriculture. Corresponding weakness in food processing added to the effect of generally weak domestic demand on manufacturing sector production. An overall strong result in the services sector was concentrated in the areas of wholesale trade, air transport and telecommunications. The expenditure based measure of GDP fell by 0.9% qoq.

In terms of demand components, a small rise in consumption, business investment and stock-building was more than offset by a 23% fall in residential investment. The overall fall in internal demand of 0.6% was reinforced by a negative net external sector contribution. An early end to the dairy season led a slowdown in export growth, while import growth slowed by less than expected.

Commentary The outturn for the June quarter was broadly in line with our expectations, although we did not expect the unusually large revisions to previous quarters. However, that factor does not affect our assessment of GDP growth going forward. We expect a modest rebound in activity in H2/00, with quarterly growth rates of around 0.5% in both Q3 and Q4.

Indicators supporting that assessment include a gradual trend increase in job advertisements, double digit tourism growth, the surprising robustness in retail sales, a consolidating construction sector, a good start to the agricultural export season, as well as the recent rebound in companies' expectations of their own trading prospects. A reversal of the increase in stocks in Q2 is likely to be a factor limiting near-term GDP growth.

In terms of the composition of growth, we forecast net exports to make a growing contribution, while domestic demand will remain relatively subdued. That profile is driven by a NZD value that is very stimulating for the export sector, but imposes significant costs on the household sector. Modestly tight interest rates are expected to reinforce the continued softness in domestic demand. As far as monetary policy is concerned, today's data imply less pressure on domestic resources. For any given amount of import cost pressure, that would suggest a slower pass-through into the CPI than assumed in the RBNZ's August forecasts. However, that factor will be more than offset by the unanticipated significant further increase in cost pressure since then. Oil prices, notwithstanding their recent moderation, are still trading significantly above RBNZ assumptions. Furthermore, the TWI today traded around 9% below the RBNZ's projection for H2/00.

Widespread anecdotal evidence of rising producer and consumer prices - despite weak economic conditions - confirms our model-driven expectation that CPI inflation will climb to around 3.5% over coming quarters and stay at or above 3% over all of 2001. The recovery in growth will reinforce the pass-through of pent-up cost pressure next year, which makes the RBNZ's projected scenario of a mere inflation spike increasingly unlikely.

With inflation likely to remain high for a considerable period, the risk of second-round effects has increased beyond what the RBNZ factored into their August projections. That is the basis for our assessment that there is a 60% chance that the Bank will undertake an insurance tightening in December of this year. A high Q3 CPI (we expect +1.3% qoq), anecdotal evidence of a bad CPI for Q4, as well as evidence of a modest rebound in growth in Q3 and Q4, are likely to convince the RBNZ that a 25 bps move on 6 December is justified.

Regarding longer term cash rate trends, we continue to forecast a peak of 7.50% in mid-2001.

Ulf Schoefisch, Chief Economist, New Zealand

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