El Nino conditions could cut GDP by up to 0.8%, Reserve Bank says

Atmospheric measures indicate strong El Nino conditions this summer that could reduce New Zealand's gross domestic product by 0.3-0.8%, a Reserve Bank paper says.

The bank, in cutting the official cash rate this morning to 2.5%, said there were a number of risks and uncertainties to its outlook including whether the current El Nino results in drought conditions and weaker output. However, given the range of New Zealand weather conditions in an El Nino, it didn't assume a drought in its current projection.

El Nino is a climate cycle in the Pacific Ocean which has a global impact on weather patterns and begins when warm water in the western tropical Pacific Ocean shifts eastward along the equator toward South America.

The likely impact on the New Zealand economy was considered in a separate research paper the central bank released today by Dean Ford and Amy Wood. (See report attached)

It said the volatile Southern Oscillation Index, which measures the stage and intensity of the atmospheric cycle, is currently almost two standard deviations below its mean, suggesting strong El Nino conditions are present. According to the National Institute of Water and Atmospheric Research (NIWA), which has warned for months that strong El Nino conditions are present in the Pacific Ocean, this El Nino could rank among the four strongest such events ever recorded.

The research paper says the 1997/98 El Nino, which had a similar Southern Oscillation Index reading to the current one, significantly affected New Zealand. The subsequent contraction in agriculture and primary food manufacturing alone shaved 0.7%age points from GDP in the March quarter of 1997 to the September quarter of 1998.

The Reserve Bank says the actual impact of the current El Nino will depend heavily on where drought occurs. Significant snowfall and more irrigation mean farms on the South Island's east coast are potentially better placed to withstand drought than those in the North Island. The 2012/13 drought, concentrated in Northland, Waikato and the Manawatu, had a large economic impact, reducing GDP by 0.9%age points.

El Nino conditions don't necessarily spell trouble for New Zealand's agricultural sector as regional events vary from one event to the next, the paper says. "Nonetheless, it is appropriate to closely monitor climatic conditions during El Nino, given the heightened risk," the researchers said.

Agriculture is hurt by drought through reduced milk production and animal growth while primary food manufacturing is initially positively affected by more animals to slaughter and then subsequently by falls due to fewer and lighter animals being slaughtered.

Milk production nationwide is already forecast to be 6% below last year's volumes this season and DairyNZ economist Matt Newman said that was due to farmers reducing feed because of cash-flow difficulties with low global dairy prices.

He said there were a lot of unknowns on the likely impact of El Nino but milk production could be reduced by up to 10% if a drought eventuates in dairy producing areas.

The paper said it was difficult to determine whether droughts in New Zealand influence global dairy prices as the country's share of global dairy production is small despite being a major exporter and doesn't tend to drive swings in global milk production growth. There is a current imbalance between global demand and supply, depressing dairy prices.

"What seems to matter more is the extent to which climatic conditions in New Zealand are correlated with those in other dairy producing regions," the paper said.

The bank's monetary policy statement today said that policy path may not need to change materially if a drought is short-lived and the exchange rate depreciated, supporting incomes and confidence through the wider economy. However if the drought effect was stronger, or the exchange rate didn't adjust, more stimulatory monetary policy may be needed.

RAW DATA: El Niño and its impact on the New Zealand economy (PDF)

(BusinessDesk)