Prepared by Dalton Nicol Reid
The Queensland floods, combined with those in northern NSW, western and northern Victoria and northern Tasmania, may turn out to be Australia’s most costliest disaster. Not in terms of lives lost, nor in terms of insurance claims, but quitely likely in terms of its broader economic consequences.
The expected impact of the Queensland floods:
- The floods created a temporary disruption to activity itself with production that would have taken place being disrupted (e.g. construction work, mining, shopping). Over all, we expect growth will be downgraded half of one percent in 2011. While this is important, it is easy to overestimate what impact it will have on GDP growth. For example, if we make the extreme assumption that no activity in Queensland took place for 1 week, then this would result in Queensland’s GDP falling by 8% in the March quarter and Australia’s GDP falling by 1½%. Over 2011 as a whole, growth would be trimmed by just 0.4%.
- Food inflation could boost headline inflation by 0.5% (but that will be transitory and looked through by the RBA), whilst shortages of skilled tradespeople and materials could also add 0.5% to inflation. It is certainly possible that higher fresh food prices boost headline inflation by 0.50%. The impact would be transitory and be reversed in late 2011. We are also likely to see an increase in the cost of skilled tradespeople as well as some goods – such as roof sheeting – that may be in short supply. Then there is the prospect of higher insurance premiums and the possibility of higher levies to fund the costs of reconstruction. Moreover, the rental market might tighten due to the destruction of property which could result in higher rents. These inflationary pressures will be more enduring and could easily add 0.50% to inflation as well.
- Rebuilding phase will provide a small net positive boost to GDP, but will be spread over multiple years, with the main benefits to be felt in the 2nd half of 2011. Most of the popular discussions about the economic impact of the Queensland floods surrounds the damage to infrastructure and property which has been estimated at anywhere between $10bn and $20bn. It is important to note that much of the reconstruction will not be an incremental increase in spending, but will displace other spending that would otherwise have occurred. That is, instead of building a new highway, the government will divert that money to repairing an existing one. Also, it should be remembered that the reconstruction process will likely take some years to complete, which also dampens the positive impact on GDP in any one year. The bottom line is that rebuilding will boost growth in the second half of 2011, but this impact will likely be modest.
- In the short term, the negative impact on activity should outweigh the inflationary pressures and prevent further monetary policy tightening and, as a result, we no longer expect that the RBA will raise interest rates in the first quarter. However, the higher inflation profile will keep a tightening bias very much in place and it seems likely that the RBA could tighten policy in May as the rebuilding phase commences. This helps explain the rally in interest rate sensitive stocks such as the retailers as people close out shorts/underweight positions. In addition there is the obvious need for a replacement of beds, couches etc which will have a short term impact on profits.
- Contractors (LLC, CDD, LEI, MAH) and building materials businesses (BLD, ABC) appear the biggest direct beneficiaries from the above summary (although some of these businesses (LEI, BLD) are likely to deliver weak first half 2011 results).
- Food inflation will also benefit the likes of WOW, MTS & WES who should maintain gross margins in a rising price environment (thus driving higher gross profits). Food deflation has been a major negative for the grocers over the past 12 months and crimping topline and profit growth. Wheat (cereal, breads, beer), sugar (candy, drinks), livestock (meat), fruit and veg are all looking like they will have significant inflation over the next 12 month period and we will see levels of inflation returning to the basket.
- Negative impact from lower coal production – RIO, BHP, QRN, WES (although this will be largely offset from the potential positive impact on Hardware sales and food inflation). Note this coal impact is short term as the coal remains in the ground and the profits will be realised when it is extracted.
- Banks – there is potentially an increase in bad loans in QLD although the impact is not expected to be material.
- Insurers will face a hit, especially Suncorp. QBE has adequate diversity and reinsurance and therefore the impact does not appear material for QBE.