Opinion: Lower than expected GDP growth unsupportive of market view of early OCR hikes

By Danica Hampton As the festive season approaches we can rest easy in the knowledge that the NZ economy continues to claw its way towards brighter times. Yesterday's GDP release showed that the economy grew 0.2%q/q in Q3. While this was a touch weaker than the 0.4% forecast by the market (and the RBNZ), it is still the second consecutive quarter of growth. What's more, the stage appears set for growth to slowly but surely accelerate through next year. Yesterday's data fits well with our expectation that the economy will expand 2.5%, on an annual average basis, across calendar 2010. While the data supports our view that the economy is broadly on the right track, the economic picture is still a tad weaker than that projected by the RBNZ. As such, yesterday's GDP release did nothing to support the market's view that the RBNZ will need to tighten earlier, and more aggressively, than the mid-2010 indicated by the December MPS. The slightly weaker-than-expected NZ GDP result encouraged the NZD to move lower. NZD/USD slipped from above 0.7020 to a smidgen below 0.6980. However, dribs and drabs of demand from a wide variety of real-money accounts provided some support for the NZD/USD sub-0.7000. Overnight, a generally weaker USD saw the NZD/USD rebound from sub-0.7000 to above 0.7050. The USD weakness was triggered by a bout of soft US data (mainly a 11.3%m/m drop in US new home sales), which cast doubts over the strength of the US economic recovery. The CAD was propelled sharply higher after Canada's Finance Minister Flaherty said China and Russia may diversify foreign reserves into Canadian dollars. For today, the backdrop of a generally heavy USD should ensure NZD/USD finds support towards 0.6980. Expect some initial headwinds ahead of 0.7070-0.7080. However, be mindful that thin holiday trading conditions can exaggerate price action and we may see quite a bit of volatility over the Christmas-New Year period. It was the night before Christmas and all through markets very few currencies were stirring"¦except for the CAD. While it sounded good, it's not strictly true. The USD did weaken against most of the major currencies last night "“ its first daily drop in over a week. However, with just one more sleep until Christmas, trading was thin and markets are well and truly winding down for the festive season. A bout of soft US data dented optimism about the strength of the USD recovery last night. New home sales unexpectedly fell 11.3% in November to 7-month low of 355,000. The other US data was also fairly uninspiring. The University of Michigan consumer confidence survey was finalised at 72.5 (vs. 73.8 forecast), personal spending rose just 0.4% (vs. 0.5% forecast) and personal income rose 0.5% (vs. 0.7% forecast). Doubts about the strength of the US recovery took a toll on the USD. EUR/USD rebounded from around 1.4250 to above 1.4350 and USD/JPY slipped from around 91.90 to under 91.40. However, CAD outperformed. Comments from the Canadian Finance Minister Flaherty saw USD/CAD fall from nearly 1.0580 to below 1.0480. Flaherty said in an interview with Bloomberg that China and Russia may diversify their currency reserves into CAD. Canadian GDP printed on the softer side of expectations, rising just 0.2%q/q in October (vs. 0.3% forecast). GBP lagged the gains seen in other currencies and spent most of night within a relatively tight 1.5930-1.5990 range. The Bank of England minutes of the December meeting showed the Committee unanimously voting to keep policy unchanged, with the £25b of asset purchases announced in November continued. The Committee are wrestling with the conundrum that although economic data have been slowly improving over time and the labour market has proved more resilient than feared, the medium-term outlook is still very uncertain. Reading between the lines, the Committee hasn't entirely closed the door on the possibility of extending its quantitative easing program. We'd be wary of reading too much into these pre-Christmas currency moves "“ as price action tends to be exaggerated by thin trading conditions. On a trade weighted basis, the USD has risen more than 5% since the start of December. After a string of upbeat US data unnerved those holding short USD positions. With speculative market positioning now looking a bit more balanced, further gains the USD will likely be hard fought (requiring either upbeat US data or worsening risk appetite). We'd like to thank all our readers for their support over the past year. We hope you all have a Merry Christmas and a safe, happy New Year. We look forward to keeping you updated on what's going on in financial markets in 2010. * Danica Hampton is BNZ's Senior Currency Strategist. All of the research produced by the BNZ Capital team of economists is available here.