Optimism dives to ‘87 crash low-point

Business confidence slumped to a 17-year low this month, but companies believe the Reserve Bank has inflation by the throat even if the economy is running short of breath.

The National Bank's May Business Outlook survey showed almost 62 per cent of companies expect conditions to deteriorate over the next year and only 5.2 per cent expect it to improve.

That makes a net 57 per cent of respondents pessimistic, compared with 48 per cent last month and 19.9 per cent in March.

The last time business confidence reached such a low-point was in the wake of the October 1987 sharemarket crash, from which the stock market, at least, has never recovered.

The economy is suffering from the strong dollar still above US70c - the level at which most exporters feel pain.

Meanwhile, high interest rates, reflecting the Reserve Bank's battle to keep a lid on inflation, and falling net migration are also putting the brakes on growth.

But National Bank chief economist John McDermott cautioned against too much gloom.

"We have a much more resilient economy than we had in the '80s," he said.

The survey's own activity index, which measures firms' expectations of their own prospects over the next year and is a strong indicator of economic growth, also fell.

A net 9 per cent of firms are optimists, down from a net 15 per cent last month.

The survey showed profit expectations were significantly negative and, as a result, businesses had reduced their employment and investment plans.

As these were the very factors that drove economic growth, the pessimistic outlook could be self-fulfilling.

"These expectations suggest economic growth of little over 1 per cent and seem on the pessimistic side," McDermott said.

Most economists expect growth of more than 1 per cent in the next 12 months.

"We are looking in the face of the low point of the cycle. The economy will cycle down this year, trough in 2006 and then start to trend up again," McDermott said.

"It's time to take a breather after 6 1/2 years of strong performance, before regathering our strength to pick up our pace again."

The survey showed sliding confidence across all sectors of the economy.

On the bright side, firms' inflation expectations were 3 per cent - down from 3.1 per cent last month - marking their first decline in 21 months.

But McDermott warned about getting carried away with the inflation outlook.

"It is only a small decline and does not yet mean we can declare victory in the war on inflation.

"Nevertheless, expectations are now moving in the right direction and the worst seems to have passed. The seven increases in the official cash rate implemented by the Reserve Bank over the past year are finally starting to bite.

"With inflation in retreat and real activity indicators showing signs of weakness, the Reserve Bank can halt its attack on inflation."

The fall-off in the construction sector's profit and hiring expectations was a strong indicator that the Reserve Bank had done its work.

"This probably needs to happen for all the inflationary pressure to dissipate, as it was this sector that was absorbing all of the available resources within the economy."

Among the casualties of the battle on inflation were the dollar, export performance and the cost of capital - which had risen "until finally business confidence was crushed".