Pessimism rising even before floods

By BRIAN FALLOW

Business confidence has taken a dive, hit by rising exchange and interest rates.

In the National Bank's monthly survey, 42 per cent of respondents expect general business conditions to get worse over the next 12 months while 14 per cent expect them to get better. The net 28 per cent pessimistic is down from a net 16 per cent in December and is the weakest since last June.

The bank's chief economist, Dr John McDermott, said that on top of the seemingly unstoppable rise in the exchange rate, people had been welcomed back to work with a surprise increase in interest rates by the Reserve Bank.

The survey closed before last week's flooding in the lower North Island.

"On the other side, responses to questions about their own firms were not much changed and continue to show the resilience of the economy."

Firms' expectations of their own activity and their hiring and investment intentions are in line with, or only slightly softer, than in December.

Expectations for export volumes remained relatively upbeat, McDermott said, but the higher dollar and interest rates had taken the edge off profit expectations.

The survey covers many small businesses which have yet to feel the effects of the higher dollar.

McDermott said that because of exporters' hedging policies, a rolling average of the exchange rate over the past 18 months was a better indicator of the exchange rate exporters were feeling than the spot rate which made the headlines.

The rolling average is around 57USc, which is still below the bank's estimate of fair value (60USc), but it is rising inexorably by 1USc a month as forward cover taken out at more favourable rates rolls off.

McDermott believes that over the next few months more exporters will cross their pain threshold in terms of the currency and make the hard decisions on staffing levels and investment that flow through to the business community more generally.

But even as the economy is slowing the survey is picking up early warning signs of rising inflation. The proportion of firms intending to raise prices over the next year has edged up over the past few months, though it remains well below the level when the Reserve Bank last started raising interest rates in March 2002.

When businesses were asked why they were looking to increase prices when the economy was cooling and when a high dollar was cutting the cost of imported inputs, the answer was usually rising labour costs, McDermott said.

Reserve Bank Governor Alan Bollard would face an increasingly tough choice this year, he said: cost-push inflation arguing for higher interest rates, but a slowing economy arguing for lower ones.