New Zealand's (NZ) solid response to contain the coronavirus pandemic is likely to translate into a less severe economic contraction than anticipated, although stricter lockdowns and borders controls imply a slower economic recovery in the long-term.

The South Pacific nation is set to witness the first recession in ten years, with the GDP likely to shrink 12.8% QoQ in the three months to June vs. -1.6% seen in the first quarter of 2020. On an annualized basis, the economy is expected to contract 13.3% in Q2 vs. -0.2% prior.

Odds of a shallower economic slump

Courtesy of the good handling of the coronavirus spread and plans of re-opening up the economy faster, the NZ Treasury Department bumped up its growth and employment forecast on Wednesday, as it published its pre-election Economic and Fiscal Update (PREFU) for this year.

According to the update, the economy likely shrank 3.1% in the year vs. the 4.6% contraction projected in the May budget. The jobless rate will rise to 7.8% by 2022, lower than the 9.8% peak seen in the previous forecast.

The latest NZ fundamentals have signaled that the economy is on a path of recovery. The country’s ANZ business confidence index improved to -26% in September vs. August’s 41.8%. Meanwhile, the fall in the manufacturing sales and wholesale volumes was not as severe as feared.

Despite the tourism being hit by the pandemic, Finance Minister Grant Robertson said most short-term indicators were less grim than predicted at the government's annual budget in May. Although the impact of the stricter shutdowns in Auckland could probably be felt in the third quarter.

When compared to a weaker global outlook, the Pacific island nation is expected to grow by an average 4.2% across 2021 and 2022 while the economic growth in Australia the US is foreseen at 3.6% and 3.5% respectively.

Further, a faster-than-expected turnaround in the Chinese economy also boosts the case for a less severe economic downturn projected for New Zealand. China is NZ’s top trading partner and dairy is the Kiwi nation’s leading export product.  

NZD/USD: Room to rise?

NZD/USD sits at two-week highs above 0.6700 in the lead up to the all-important US Federal Reserve (Fed) monetary policy decision following which the NZ Q2 GDP figures will be released on Wednesday at 2245GMT.

The FOMC decision will have a major impact on the market sentiment, which will likely emerge as the main driver for the FX market. Therefore, the kiwi pair will take cues from the broader risk trend, which could influence the reaction on the GDP publication.

A dovish Fed followed by a positive surprise on the NZ GDP figures could likely to bode well for NZD/USD, allowing for a rally towards 0.6800. While the Fed’s concerning tone on the US economic recovery could dampen the market mood and limit the impact of a shallower NZ recession.