Optimistic mood takes a tumble

Business confidence tumbled in the National Bank's latest survey as firms faced an uncertain political outlook and mounting expectations of higher interest rates.

Only 7 per cent of firms responding expect general business conditions to improve over the year ahead; 62 per cent expect them to get worse.

That makes a net 55 per cent pessimistic, much worse than the net 38 per cent pessimism last month.

Pessimism is not far above May's net 57 per cent, which was the weakest confidence had been since early 1988.

The bank's chief economist, John McDermott, said when business leaders looked out the window they did not like what they saw: a slowing economy, rising inflation and the country's external debt rising without any apparent bounds.

In addition, he said, the survey responses came in during during the period of limbo between the election and formation of the new Government.

Confidence had not been helped by the slow resolution to coalition negotiations, and the prospect of an untidy multi-party arrangement had probably not helped either.

The survey also took place amid mounting conviction in the money markets and among Reserve Bank-watching economists that Governor Alan Bollard will tomorrow raise the official cash rate 25 basis points to 7 per cent. The proportion of firms expecting higher interest rates jumped to a net 67 per cent from 31 per cent last month.

Firms' expectations about their own outlook weakened, with a net 12 per cent expecting better times, down from a net 16 per cent in September.

McDermott said that was a level consistent with the economy growing at an annual rate of only 1 per cent. At that rate, the economy's engine could easily stall, triggering the dreaded hard landing or recession.

The economy had a mid-year burst of activity, expanding 1.1 per cent in the June quarter.

But that might turn out to be a dead cat bounce, said McDermott - referring to the saying that even a dead cat will bounce if dropped from a great enough height.

Consistent with the decline in their own activity outlook, firms have dialled back their expectations for exports, profits, capacity utilisation and hiring.

Their inflation expectations, closely watched by the central bank, have jumped to 3.3 per cent from 3.1 per cent last month.

But the proportion of firms expecting to raise their own prices increased only marginally from a net 24.9 per cent to 25.5 per cent.

McDermott said Bollard faced the predicament that interest rates needed to fall to prevent a recession, but needed to rise to stabilise inflation expectations and keep the inflation beast in its cage.

The monetary policy framework, which served the country well for over 15 years, made controlling inflation the bank's main goal; growth was a secondary consideration.

Companies have scaled back their investment plans, with a net 6 per cent expecting to increase investment compared with 12 per cent last month. Even so, business investment intentions remain above their long-term trend.

McDermott expects business investment to provide some support to the economy even at the trough in the economic cycle, because long-term interest rates remain low and the relative price of capital to labour is strongly in capital's favour amid a labour shortage.