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Better but still weak business confidence: a signal to cut the OCR?

Tuesday 15th January 2019

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ANZ Bank economist Liz Kendall says the New Zealand Institute of Economic Research’s latest quarterly survey of business opinion shows the Reserve Bank will eventually need to cut interest rates.

Other economists agree that deteriorating business profitability raises risks that future employment, investment and economic growth generally could deteriorate, but they’re still picking the next move in the official cash rate – eventually and definitely not soon – will be up.

Bank of New Zealand is sticking to its view that the economy is running hot, even though economist Craig Ebert acknowledges that if the question is 'how hot?', the QSBO’s answer is “not very.”

Kendall says the QSBO’s findings “are consistent with our view that the economy is not performing well enough to achieve a durable lift in inflation.

“We see the Reserve Bank cutting the OCR late this year to give the economy a pick-me-up,” she says.

The survey showed business sentiment improved somewhat in the December quarter but remained deeply pessimistic.

However, firms’ views of their own businesses’ prospects in the next three months nudged upwards into positive territory, reflecting improving demand.

A net 18 percent of businesses still expect business conditions to worsen during the next six months, although that’s significantly better than the net 28 percent expecting worsening conditions in the previous quarter. That had been the worst reading since March 2009.

Now, a net 17 percent expect their own business activity will pick up in the next three months, up from zero three months ago, and a net 4 percent reported an improvement in the December quarter.

Pessimists and optimists are netted off to produce the overall index figures.

NZIER says the own activity measure tends to be a better indicator of GDP than the headline confidence figure.

Kendall says the downbeat mood reflects “headwinds the economy is facing with the cycle now looking tired".

"Firms are facing high labour costs, margin pressure and credit constraints.”

The survey showed a net 22 percent of firms experienced deteriorating profitability in the December quarter and a net 15 percent are expecting a fall in profitability this quarter.

“Cost pressures are still evident and there was a net 48 percent of firms reporting rising costs – we haven’t seen a reading this high in over a decade,” Kiwibank economist Jeremy Couchman says.

But only a net 20 percent raised their prices in the December quarter and 21 percent expect to raise prices this quarter, despite expectations of a net 36 percent that their costs will rise further this quarter.

“Which raises a very important question: why are firms not increasing prices to recoup margin?” asks ASB economist Jane Turner. “In the face of deteriorating profitability, how will firms respond if they cannot recoup margins through prices? There has traditionally been a reasonably close relationship between profitability and employment.”

Nevertheless, BNZ's Ebert dismisses those who say the New Zealand economy can’t possibly be overheating because CPI inflation is still under control.

BNZ is forecasting flat headline CPI inflation for the December quarter - due for release on Wednesday, Jan. 23. That would put calendar 2018 inflation at 1.8 percent, not far off the midpoint of the Reserve Bank's 1-to-3 percent target range.

“We’d suggest a broader look around. And a chat with the NZ business sector whose resources are demonstrably stretched. If that’s not a tried and true indicator of the economic cycle, we don’t know what is,” he said.

Certainly, the survey highlights what a problem the labour shortage is. While a net 5 percent of businesses hired more staff in the December quarter and a net 13 percent is planning to hire this quarter, a net 53 percent say skilled labour is hard to find. That's up from 44 percent three months ago.

Even unskilled labour is scarce – a net 35 percent say it’s hard to find, up from 29 percent three months ago.


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