Soaring costs lower business morale

Mounting costs are eroding firms' confidence about their outlook, says the National Bank's monthly survey of business sentiment.

In the August survey, 31 per cent of firms expect their own activity to lift in the year ahead but 17 per cent expect it to decline (the other 52 per cent expect no change).

The net 14 per cent expecting to be busier is down from 15 per cent in July and at a level historically consistent with the economy growing by only about 1.5 per cent in the year ahead.

National Bank chief economist John McDermott said firms' views of their own prospects were a better barometer of the economy than their views of the general business situation.

That improved last month but pessimists still outnumber optimists, with a net 32 per cent of firms expecting business conditions to worsen compared with a net 42 per cent in July.

The improvement in confidence about the general environment was most notable among retailers, whose morale has improved since the Lions tour.

The survey was completed before the National Party announced its tax policy and so is unaffected by any disappointment about having to wait for cuts in company tax.

McDermott said high oil prices were the number one concern among businesspeople he encountered on a recent national "roadshow".

The relentless rise in the world price of oil - about 9 per cent in the past month alone - pushes up firms' costs and reduces the amount consumers can spend on other things.

In addition, during the past month the exchange rate has retraced some of its decline over the two months before that, to be 1.3 per cent higher on a trade-weighted basis than a month ago.

Businesses in the south were concerned about unseasonably dry weather, with negative implications for agricultural production and electricity prices.

The past month has also seen further tightening in the labour market, with unemployment falling to 3.7 per cent, the lowest among developed economies, and associated with that rising wage inflation.

Producer price data from Statistics New Zealand last week showed firms' input costs, not just for energy but across the board, growing faster than their output prices, implying a squeeze on profit margins.

Consistent with that, the National Bank survey continues to show more firms expecting profits to fall than to rise, and weak hiring and investment intentions.

McDermott said employment and investment intentions were running below their long-run averages at levels consistent with sub-par economic growth.

Mounting costs had firms thinking about cutting those they could control and passing on those they could not.

A net 26 per cent of firms now expect to raise their prices, up from 22 per cent in July.

And expectations of inflation have inched up, to 2.96 per cent from 2.91 per cent. "This may be a conservative expectation because, with rising oil prices, inflation may well step outside the [1 per cent to 3 per cent] target band for a while," McDermott said.

"A while" could be 18 months, long enough to raise general expectations about inflation and feed through to higher wage demands.