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Toting Katrina's 'severe distortions'

S&P economist Beth Ann Bovino provides a rundown of the storm's likely impact on production, GDP, consumer spending.
/ Source: BusinessWeek Online

Hurricane Katrina could wind up being the most devastating storm to hit the U.S. Early forecasts of insured losses run as much as $26 billion, beating the $21 billion in insured losses from Hurricane Andrew, which hit Florida in 1992, according to news reports.

As far as damage to the economy, the storm is likely to drop third-quarter gross domestic product (GDP) growth by 50 basis points, figures Beth Ann Bovino, senior economist at Standard & Poor's. She also expects consumer sentiment and production to be hurt. However, the economy should get a boost from rebuilding activity in the coming months. She also points out that consumer spending has held up, despite the climb in oil prices.

BusinessWeek Online's Karyn McCormack recently spoke with Bovino about the economic impact of the storm. Edited excerpts follow:

What kind of an impact does S&P expect Katrina to have on U.S. economic activity?
Certainly the damage done by Hurricane Katrina was major. We expect it will now shave off 50 basis points from our GDP estimate of 4.6% for the third quarter. If oil production and ports are damaged more severely, it may be higher.

However, likely repairs from hurricane-related damage should boost GDP in the following three quarters. This is largely because of rebuilding. We expect the fourth quarter will get a lift in the growth rate, but the dollar amount of GDP will still be lower than in the second quarter. However, we think the GDP dollar value will be higher in the first quarter of 2006 because of rebuilding.

How will it affect key economic reports in the next few months?
The hurricane will cause severe distortions. For example, I mentioned the GDP impact. We also think that sentiment indicators will be hurt, as well as production, not just from damage-related issues, but also because of higher oil prices. Consumer spending may slow.

I should add that industrial production is the most heavily affected report. Power outages and distribution delays affect production for utilities, mining, and manufacturing. Employment should fall short from the hurricane disruption but then get a boost from rebuilding afterwards. The payroll report reading is well before the hurricane, so it shouldn't be affected, but initial claims should be depressed as employment centers are closed.

Given that the hurricane hit late in the month, some surveys for the month may not be affected, while others may feel its impact in both months.

Which economic sectors will be hardest hit?
Of course, energy-related sectors will be hit. Louisiana has a big concentration in the industry. Aside from energy-related production, the ports in that region are a significant factor to U.S. production and growth.

Moreover, to a lesser extent, Florida's trade, agriculture, tourism, and construction will also be hit. After the negative shock to these industries, we're likely going to see a real boost in construction-related activity. We're going to need construction workers.

What kind of positive impact on GDP could rebuilding efforts have?

We think GDP will get a boost from rebuilding. It will start in the fourth quarter, and we expect that to continue to support GDP growth in the first half of 2006. Due to rebuilding activity, at least 20 basis points will be added to growth in the first half of 2006.

As far as the energy market, what effect would a sustained period of $70-plus oil and $3-plus gasoline have on U.S. growth?
What we've found is adding another $10 in oil for a sustained period, or at least one year, could shave 50 basis points off growth. If this is sustained, it could be a significant drag on consumer spending and production.

Businesses won't produce as much if it costs too much. In fact, we're surprised that consumer spending hasn't slowed so far, given the recent run-up in gasoline prices. Several factors account for this, but one is that we just don't spend that much on energy as we did in the past. Household spending on energy is now about 5% of disposable income, vs. 8% in 1980.

How do you think U.S. consumers will react? Will spending remain strong amid all the post-Katrina uncertainty?
I do think sentiment will be hit. Spending may slow, but the consumer is very resilient. We wouldn't be surprised to see consumers continue to spend.