Inflation fears fuel business pessimism

Business confidence continues to fall as firms grow more anxious about inflation and slowing growth prospects, which the National Bank says will eventually hurt the strong jobs market.

The bank's August Business Outlook Survey showed a net 34 per cent of firms expected business conditions to deteriorate over the coming year.

The survey's "own activity indicator" - a measure of each company's assessment of its own prospects, which has tended to be closely related to economic growth - fell to a net 6 per cent of optimists, its lowest reading in five months.

But inflation expectations were at their highest in 15 years, a net 3.5 per cent of firms expecting inflation to rise.

National Bank chief economist Cameron Bagrie said that reflected the uncomfortably high current inflation.

Investment and employment expectations also slid.

Bagrie said that, combined with the lower "own activity" reading, suggested the economy would grow by less than 1 per cent over the coming year.

A "soft landing" implied annual economic growth of around 2 per cent, a "hard landing" 1 per cent, and no growth would be a "crash landing".

"What we're seeing at the moment suggests that the economy is going to be tilting more towards 1 per cent, and I think that's a byproduct of the strong inflation," Bagrie said.

He believed a sustained period of slow growth was necessary to curb inflation and there would probably be little prospect of a recovery before 2008.

Today's prospects seemed "a step shy of stagflation", although that could change if inflation rose and growth prospects weakened further.

High inflation and low growth was "an ugly combination for firms' earnings" and that was reflected in weaker profit expectations, "the weakest economic barometer in the survey".

A net 13.7 per cent of firms were pessimistic in their profit outlook.

Retailers were particularly downcast - a net 24 per cent expected profits to fall and a net 11 per cent expected their own activity to decline.

Subtle shifts in the composition of recent retail spending suggested household incomes were being squeezed by higher petrol, mortgage, energy and rates costs, Bagrie said.

Meanwhile, pressure on earnings had shown up in firms' reported earnings and in the guidance they issued during the current sharemarket reporting season.

Firms had borne the brunt of the economy's weakening through lower earnings, Bagrie said.

Households had been reasonably insulated by jobs growth and wage gains, but that could change.

"We are in an economic environment where growth is going to be sluggish and you've got pressure on the bottom line coming from rising costs.

"The issue for 2007 is how do businesses respond to the tougher economic environment and pressure on earnings?

"I think there is going to be a very strong focus on costs, and the million dollar question is when that really heads into the labour arena."

Meanwhile, Bagrie said, the Reserve Bank would probably take comfort from signs of a slowdown in the real economy.

But interest rate cuts would not come until the bank was sure slow growth was dissipating inflationary pressures.


AUGUST BUSINESS CONFIDENCE

* 34 per cent net pessimism.

* Up from 31 per cent last month.

* Trading expectations show 6 per cent net optimists

* Down from 15 per cent last month.