Time to get used to high interest and wage rates

An unholy trinity of wage inflation, rising fuel costs and a weakening dollar is weighing on business leaders' minds both at the big end of town and among small and medium-sized enterprises.

They were asked to rate concerns on scale of one to 10, with 10 representing strong concern. None of the options offered stood out as head and shoulders above the others, but there was a clear consensus about a cluster of factors which are pushing up costs at a time when domestic demand is weak and profit margins are under pressure.

Wage increases top the list for corporate chief executives and are a close equal second for SMEs. Wage rates and salaries are running around 5.5 per cent ahead of where they were a year ago.

No wonder, when inflation has hit 4 per cent and even the Reserve Bank is warning that it is likely to stay around that level for several quarters and not fall back within its 1 to 3 per cent target band until late next year.

Nervousness about what headline inflation numbers like that will do to inflation expectations and pay settlements has governor Alan Bollard keeping interest rates high despite a sluggish economy. He needs to be confident, he says, that inflation is heading back comfortably within the target range before easing back on the monetary brakes.

Underlying chief executives' concern about wage inflation may be a recognition that the country has moved to a permanently, structurally tight labour market, at least when compared with the 1990s.

Shedding labour in response to a thinning order book is riskier than it used to be in an environment of chronic skill shortages, and an unemployment rate which is low by historical and international standards.

This is reflected in the fact that despite the economic slowdown and the fact that 61 per cent of bosses are less optimistic about the outlook than they were a year ago, as many CEOs expect to increase staff levels as reduce them over the next 12 months. Among smaller businesses those expecting to increase staff levels outnumber those planning to reduce them by more than two to one.

Petrol costs, which top the SMEs' list of concerns and are a close equal second among the corporate CEOs, have risen by nearly a third over the past year.

After bobbing around the 80c a litre mark through the 1990s the petrol price jumped to $1 in 2000, then drifted back a little before soaring to more than $1.70 now.

Domestic taxes make up about 40 per cent of the price at the pump, diluting only partially the instability premium built into world crude prices at a time of war in Lebanon, insurgency in Iraq and a pretty serious failure of minds to meet between the Western powers and Iran over the latter's nuclear ambitions.

Electricity prices are the lesser concern but not by much.

As measured by consumers price index, electricity prices are up 6 per cent over the past year and by a third over the past four years.

Prices for commercial and industrial users have risen less rapidly than for households but they have still been climbing in real terms.

The level of the New Zealand dollar is another major concern. Since the start of the year it has fallen 11 per cent against the US dollar and 14 per cent on a trade-weighted basis.

A weaker exchange rate benefits exporters - eventually and provided they have enough power in the chimerically relationship to ensure the gain does not all go their offshore counterparties.

But New Zealand Inc imports more than it exports, about 20 per cent more in the year ended July.

A weaker kiwi dollar pushes up the cost of imported fuel and other inputs such as materials and components, as well as capital plant and machinery.


Despite a weaker dollar making imported capital goods more expensive, the survey suggests the lift in the level capital expenditure which has marked the past few years will be maintained.

More firms expect to increase capex over the next year than reduce it, especially in information technology. Together with the evidence of labour hoarding, that suggests firms are "looking through" the current downturn.

But the possibility of further interest rates rises remains a concern, along with the corporate tax rate, the state of transport infrastructure and the implications of a gaping current account deficit.

That is despite the fact that Dr Bollard has maintained in monetary policy pronouncements that he does not expect to have to raise the official cash rate again this cycle.

And it is despite the Government's business tax reform discussion paper that includes the prospect that the company tax rate will be cut to 30 per cent.

Increased funding for roads was a major theme of the last Budget but the deficit in transport infrastructure, not least in Auckland, may take long to correct.

And the current account deficit, which at $14.5 billion or 9.3 per cent of gross domestic product is spectacularly bad by international standards, remains the economy's Achille's heel.

That degree of dependence on the willingness of the rest of the world to fund the deficit leaves its vulnerable to a change of sentiment towards New Zealand. Even short of that it increases the extent to which the economy's output belongs not to New Zealanders but to the foreign providers of capital and credit.