Opinion: Recession to get worse in Q3

By ASB Chief Economist Nick Tuffley and ASB Economist Jane Turner We expect GDP to contract 0.3% in Q3. It will bring the economy into its third quarter of recession, following declines of -0.3% and -0.2% in Q1 and Q2 respectively. Over Q3 we expect to see most sectors of the economy contract. Weak goods exports (down 2.6% according to the overseas trade indexes) will weigh on the primary and manufacturing sector, with the exception of the drought-related recovery in dairy and electricity production. Construction activity will continue to decline, on falling residential construction as housing demand slumped over 2008. Retail volumes are expected to also drag on growth, with particular weakness in spending on motor vehicles and fuel purchases. Transport activity is likely to have slumped over Q3, under the strain of high fuel prices, slowing economic activity, and lower visitor arrivals. Ongoing weakness in house sales and weak credit growth suggests that growth in finance and business services faltered. The only pockets of strength in Q3 are likely to be a drought related recovery in dairy and electricity production as well as continued growth in government spending and increased employment in education. GDP is estimated on a production basis and an expenditure basis. While the production-based estimate is the official measure of quarterly GDP growth, the expenditure breakdown often gives a better picture of underlying drivers behind economic growth. Reflecting the weakness in retail spending, a decline in private consumption is expected to drag on GDP growth. Residential investment will post the biggest decline, as already indicated by the 8% drop in residential building work. The largest drag on GDP will come from declines in Other Investment. Behind the drop is the reversal of the previous quarter's surge in plant and machinery equipment due to some one-off large items in the previous quarter. Offsetting some of this weakness will be a pick up in non-residential building construction. Export growth is likely to be weak. However, imports are likely to fall by a larger degree, leaving the possibility for a positive contribution to growth from net exports. Looking ahead, we expect the recession to continue through to mid-2009. Activity will continue to struggle under the uncertainty generated by further escalation in the credit crisis. Tax cuts should have provided a boost spending and kept the economic growth afloat; however we expect increased economic uncertainty will see much of the windfall being saved. Despite substantial government and central bank action, global credit markets remain disrupted and the global economic outlook continues to deteriorate. Falling global demand has made our export-led recovery look increasingly fragile, with manufacturing and tourism likely to bear the brunt of the decline in demand. The climate of uncertainty has affected business confidence, with investment and employment plans scaled back aggressively. With rising unemployment and ongoing uncertainty, consumer confidence also remains weak despite lower petrol prices, falling interest rates and tax cuts. * ASB's weekly Economic Notes are available here.