Clouds gather over economy

Business confidence has plunged to its lowest level since the winter of discontent in 2000 in the National Bank's monthly survey.

Fifty-five per cent of firms in the survey expect the general business environment to deteriorate over the next year and only 7 per cent expect it to improve.

That makes a net 48 per cent pessimistic, the worst since a net 56 per cent in 2000, and represents a sharp fall from last month when a net 19 per cent of firms were pessimistic.

The bank's chief economist, Dr John McDermott, said it was difficult to pinpoint a single trigger for the avalanche of negativity.

It might be the fall in share prices in New Zealand and around the world, the latest rise in interest rates, wage demands, the petrol tax or the fact that the dollar seemed to be stuck above 70USc and firms' forward cover at more comfortable exchange rates is progressively running out.

Giving weight to the drop in overall confidence about the economy, which can be volatile, is the fact that it was spread across all sectors and mirrored in a marked deterioration in firms' views of their prospects.

The proportion of firms expecting their own activity to increase - measured by the activity outlook index - has dropped from a net 30 per cent to a net 15 per cent.
That indicator has proven a good barometer of economic growth and the latest result is consistent with the economy heading for a "hard landing", with annual growth slowing to around 1 per cent from 4 per cent last year, Dr McDermott said.

"Costs are rising for many firms, with higher oil prices and rising wage demands, which makes them more nervous."

Even though more firms are indicating they will pass higher costs on to their customers - which will concern the Reserve Bank - profit expectations have fallen sharply, from a net 6 per cent of firms in March expecting improvement to a net 8 per cent expecting profits to fall.

Hiring intentions and investment intentions have also dropped.

Firms' expectations of inflation have crept above 3 per cent for the first time in four years. In addition, a net 30 per cent of firms say they intend to raise their own prices, up from 27 per cent last month.

This increases the risk of a worst-of-both-worlds outcome of weak growth but high inflation. There could be a self-fulfilling belief that growth has hit the skids, while the Reserve Bank raises interest rates anyway because its bottom line is always to protect confidence that this is a low-inflation economy.

A net 60 per cent of firms expect interest rates to rise, even though the financial markets have begun to "price in" some chance that rates will fall before the end of the year and 13 out of 14 economic forecasters in a Reuters poll last week expect a steady official cash rate for the rest of the year.

The decline in confidence was sharpest among retailers and service sector firms.

Dr McDermott said businesses were being hit with a barrage of wage demands. Although it was natural for wages to rise in response to skill shortages, the widespread belief that employees had not shared in the benefits of economic expansion was disconcerting.