Rising costs squeeze confidence in NZ economy

Business confidence faltered this month as firms exposed to the domestic economy face slimmer order books and a squeeze on profit margins.

Respondents to the National Bank's monthly business outlook survey are about as gloomy about general business conditions over the next 12 months as they were last month.

Pessimists outnumber optimists three-to-one to give a net 31 per cent expecting conditions to worsen, compared with a net 32 per cent in April.

Their views on their own firms' activities over the year ahead - a more reliable indicator - retraced some of the recovery recorded last month. A net 10 per cent expect to be busier, down from a net 15 per cent in the April survey.

Their investment and hiring intentions remain largely unchanged, in positive territory but only just.

The bank's chief economist, Cameron Bagrie, said that based on past relationships between those indicators and economic performance, the economy was on track for 1 per cent to 1.5 per cent growth over 2006.

Retailers recorded the steepest drop in expected activity. A net 6 per cent expect sales volumes to shrink over the year ahead, down from the net 3 per cent expecting to continue growing last month.

A net 27 per cent of retailers expect profitability to worsen, compared with a net 18 per cent last month.

Another indicator of a soft domestic economy is a net 20 per cent of construction firms expecting residential building work to decline, up from a net 14 per cent in April.

"These are the interest rate-sensitive sectors," Bagrie said. "Tight monetary policy and a squeeze on incomes from higher petrol prices are having a substantial impact."

He expects households to go through a period of rebuilding precautionary savings. "And that is a welcome leg to the cycle because, let's face it, we have been borrowing and spending our way to growth."

With growth sluggish and costs rising, firms' bottom lines would be under pressure.

"Businesses are answerable to shareholders and I don't think it will go down too well if they are presenting earnings projections for next year that are down 5 or 10 per cent. So there will be a strong focus on costs", Bagrie said.

"The attitude of spending a buck to make a buck which has prevailed for the past four years is not going to work."

Overall, a net 15 per cent of firms expect their profits to decline, up from 8 per cent last month.

Bagrie said that was one of the weakest indicators in the survey and testified to the powerful role being played by margins in dampening the flow-on from input costs to output prices.

Even so, the net proportion of firms intending to raise their prices has increased to a five-year high.

"We suspect higher petrol prices account for the leap, although retailers also appear mindful of the deflated dollar which is forcing up import prices."

Bagrie said the Reserve Bank's pulse would be raised by a jump in inflation expectations to 3.3 per cent from 3.1 per cent in the April survey.