Building sector cost pressures: Stagflation risk as profits slide, new survey reveals

Profitability in the building sector is being squeezed as firms face rising cost pressure but are unable to pass that on to buyers, a new business confidence survey shows.

The latest Quarterly Survey of Business Opinion (QSBO) survey conducted by the NZ Institute of Economic Research (NZIER) shows overall confidence now at its lowest since March 2020, when the pandemic first hit.

It prompted ASB economist Mark Smith to warn that stagflation may be on the horizon.

Stagflation is a state where the economy is suffering from high inflation and recession - the worst of both worlds.

The QSBO for the June quarter made grim reading and offered "little to cheer optimists", Smith said.

"[It] depicted stagflation-like conditions for the business sector, with shrinking economic activity, still intense capacity pressures and soaring prices and costs."

The risks of a hard landing for the economy continued to increase, although he noted that recession was still not ASB's base case.

Building sector facing the squeeze. Photo / NZME

If there was a bright spot it was that the survey showed the resilience in economic conditions in recent months, said Westpac senior economist Satish Ranchhod.

"The survey gauge of trading activity over the past three months nudged higher, albeit to a still low level of -0.9. That's consistent with modest – but still positive – economic growth in the June quarter," he said.

"It certainly doesn't point to a second quarter of decline in economic activity after GDP sank in March as a result of Covid-related disruptions."

Consistent with the resilience in activity, there had been a pickup in hiring and overtime worked through the June quarter, he said.

"The number of businesses who are looking to take on new staff also remains elevated."

The services and building sectors were most downbeat in the June quarter, the QSBO found.

A net 71 per cent of services sector firms and a net 70 per cent of building sector firms expect a worsening in conditions.

For both these sectors, it was a big turnaround from the optimistic mood a year ago, said NZIER principal economist Christina Leung.

Despite the solid pipeline of construction work, the building sector was facing acute capacity constraints stemming from a shortage of workers and materials, she said.

"This is underpinning strong cost pressures, but the proportion of firms who were able to raise prices has fallen. "

There were signs that demand was starting to slow, she said.

The survey showed a decline in architects' reported activity with regards to housing construction work.

However, in contrast, the pipeline of government construction work rebounded strongly, and there had been a slight pick-up in the pipeline of commercial construction work.

A net 22 per cent of building sector firms reported materials as the primary constraint on their business. About 53 per cent of building sector firms reported stocks of raw materials as being too low. This was a sharp lift from the 11 per cent in the previous
quarter.

This had led to a further deterioration in profitability for the building sector, said ANZ senior economist Miles Workman.

However, labour shortages were still the main concern with 57 per cent of firms in the sector reporting that as the primary constraint on their business.

The latest QSBO told the same broad story as last week's ANZ Business Outlook, he said.

"Cost and inflation indicators are still far too high for the RBNZ to pause for breath just yet," he said.

"With a fresh wave of Omicron seemingly brewing, supply disruptions seem likely to remain the dominant economic force for some months yet, despite the clear housing slowdown."

Besides the continued uncertainty over the Covid-19 outbreak, businesses were also now grappling with the intensification of cost pressures and higher interest rates, Leung said.

A net 62 per cent of businesses expect a deterioration in general economic conditions over the coming months – a marked increase from the net 34 per cent of businesses who felt pessimistic in the previous quarter.

Expectations of higher interest rates having a negative impact on demand appeared to be the driver of the downbeat mood in the services sector, Leung said.

Christina Leung is a principal economist with the New Zealand Institute of Economic Research. Photo / Mike Scott

A net 95 per cent of services sector firms expected interest rates to rise over the coming year. And while more services sector firms were facing higher costs, a greater proportion had also increased prices.

Retailers remained downbeat with a net 61 per cent expecting a worsening in economic conditions and have reduced staff numbers in the face of weaker demand.

"Businesses are continuing to pare back on investment plans in the face of uncertainty over the continued impact of the Covid-19 outbreak, geopolitical tensions abroad and higher interest rates," Leung said.

A net 15 per cent of businesses planned to reduce investment in buildings, while a net 13 per cent plan to reduce investment in plant and machinery.

Businesses were downbeat across most regions, with Taranaki the only region where optimists outnumber pessimists – a net 4 per cent of Taranaki businesses expected an improvement in general economic conditions.

In contrast, 93 per cent of Wellington businesses expected a worsening in general economic conditions over the coming months.

This is a sharp turnaround from the 31 per cent of businesses feeling optimistic in the previous quarter. Nelson businesses were also very pessimistic, with a net 81 per cent expecting a deterioration in conditions.