Growing gloom fuels rate cut hopes

By BRIAN FALLOW economics editor

A steep fall in business confidence in the National Bank's October survey has reinforced expectations that the Reserve Bank will cut interest rates by half a percentage point on November 14.

Of the firms surveyed, 35 per cent expect general business conditions to worsen in the next 12 months, and 16 per cent expect them to improve.

The net 19 per cent pessimism compares with a net 13 per cent expecting better times in the previous survey, which was taken just before the terrorist attacks on the US. It is the third steepest drop in the survey's 13-year history.

More ominously, there has also been a big drop - the second steepest - in firms' expectations about the outlook for their own activity.

A net 18 per cent expect their activity to rise over the next 12 months, down from a net 39 per cent last month.

While it is still in positive territory, this indicator is well below its average level of 30 per cent and corresponds to an economy growing at a below-trend rate of only 1 to 1.5 per cent a year, says National Bank chief economist John McDermott.

An Institute of Economic Research confidence survey, taken immediately after the attacks on September 11, showed a sharp fall in "headline" confidence, but found firms still relatively buoyant about their own short-term prospects.

"Now firms are starting to see the flow-on effects in their own order books," Dr McDermott said.

One respondent said weekly orders had been 50 per cent below budget since the terrorist attacks.

Another said he "had never seen so much risk in pastoral farming: extremely high prices for livestock, fragile world markets, currency surely on its lows and the climate looking dry."

The drop in confidence is universal - not only in export-oriented manufacturing and agriculture, but among construction firms and the retail and services sectors, which are exposed to tourism.

Profit expectations have fallen sharply. Hiring and investment intentions have tumbled.

Expectations that interest rates would rise over the coming year have now been reversed, with a net 16 per cent expecting a fall.

"They are almost crying out for the Reserve Bank to help underpin confidence," Dr McDermott said.

The National Bank has joined the ranks of forecasters calling for a cut of 50 basis points the next official cash rate review on November 14. "At this point 25 points just looks like tinkering."

The futures market already had almost a 50 point rate cut priced in, with a 50:50 chance of a further 25 points in January.

The National Bank has revised its own forecasts for the coming year down sharply. Previously it had thought NZ had enough momentum to escape the international downturn relatively unscathed.

But it has now cut its GDP growth forecast for the next 12 months from just under 3 per cent to 1.3 per cent.

The Bank of New Zealand's chief economist, Tony Alexander, explains the dilemma for businesses having to plan in such an uncertain environment:

"Does one prepare for the forecast strong acceleration in world growth from the middle of next year, or for the risk that things spiral downward into an extended world recession with no recovery until 2003?

"Although we are forecasting the former scenario, we would suggest preparing for the latter. If you keep stock levels up, and continue to hire staff and expand facilities in expectation of an upturn, your capital would be severely eroded if the world recovery is delayed until 2003."

Bankruptcy could result, he said.

"On the other hand, if you reduce stock levels, place a cap on staff numbers and put expansion plans on hold, then if growth does surge from mid-2002 you simply risk losing market share, having a few unsatisfied customers and paying through the nose for extra staff as production is only slowly ramped up."

The BNZ says signs of a softening economy include:

* Reduced retail sales in August and credit card billings suggesting September sales were weak

* Lower imports of consumer and capital goods

* Non-existent house price inflation and dwelling permits down on a year ago

* Low growth in job advertisements

* A slump in business and consumer confidence.

Dr McDermott said the survey's own-activity indicator was closely watched by the Reserve Bank because it was closely linked with general economic activity.

This was only the fourth time it had been below 20 per cent.

It fell steeply in the middle of last year because of concerns about Government policy changes in the labour laws and ACC, but recovered.