Business confidence surges, but NZIER sees no 'smoking gun' for urgent RBNZ rate hike (Update 4)

The New Zealand Institute of Economic Research's (NZIER) Quarterly Survey of Business Opinion shows business confidence soared in the March quarter from the December quarter, but the NZIER said the economic recovery remained shallow and fragile. (Updated to include; * chart, *comments from ASB economist Christina Leung on why a June 10 OCR hike is still on, * comments from Westpac's Brendan O'Donovan on why a June 10 OCR hike is till on, * comments from BNZ economist Stephen Toplis on why this result was disappointing and means a July hike is now more of a possibility) NZIER Principal Economist Shamubeel Eaqub said the survey did not provide a 'smoking gun' that would cause the Reserve Bank to raise the Official Cash Rate (OCR) urgently. The next OCR decision is due on April 29, but most economists expect the Reserve Bank to hike the OCR from its current record low of 2.5% on either June 10, July 29 or September 16. This chart shows the correlation between the QSBO's measure of expected domestic trading activity in tandem with GDP and actual domestic trading activity. It shows expectations of a sharp rebound, but a relatively subdued actual rebound so far.

NZIER’s Quarterly Survey of Business Opinion (QSBO) revealed soaring business optimism in the March 2010 quarter, despite a shallower than expected recovery. A net 36% of firms expect conditions to improve over the next six months, compared to 23% in the December quarter (on a seasonally adjusted basis). “Firms are optimistic and their performance has been improving. But there is a growing sense of realism around expectations of the recovery. To date the recovery has been more gradual than firms expected. New hiring has been slow to pick up, despite positive intentions. A shallow recovery is in place, but the outlook is still fragile,” said Shamubeel Eaqub, Principal Economist at NZIER. “The QSBO is consistent with a shallow economic recovery and a still weak labour market. Inflationary pressures, both near term and medium term, are subdued. There is no smoking gun in the QSBO for the Reserve Bank to raise interest rates urgently.” Eaqub said. Capacity utilisation nudged down in the March quarter (90.5% from 91.1%). This measure has been volatile recently, due to large inventory adjustment in the primary sector. Other measures in the survey suggest capacity pressures are subdued. The labour market remains soft. New hiring is beginning to improve, but at a much slower pace than hiring intentions suggest. Labour is generally easy to find, although less so compared to the depths of the recession. “Cost pressures remain low. Firms are beginning to raise prices, but at a slower pace than they would like. Firms have been unable to pass on cost increases, as they had little pricing power during the recession. Profits weakened as a result, but a net 2% of firms expect higher profits driven by improving sales and margins.” Eaqub said.

The RBNZ has stated its need to see a self-sustaining recovery before it would begin to remove monetary policy stimulus, and today's QSBO suggests such a recovery is in place. Furthermore, the continued tick up in pricing intentions points to inflation pressures building up over the coming year. However, the decline in activity and profitability experienced over the past quarter tempers the strength in the headline indicators somewhat. Given the need for the RBNZ to strike a balance between providing support to the fledgling recovery while keeping inflation pressures in check, we continue to expect the RBNZ will commence its tightening cycle in June with a 25 basis point OCR increase.

The activity measures of the QSBO should further persuade the RBNZ that the economy is recovering in line with their forecasts (they expect 0.9% growth in Q1 GDP). Similarly, the evidence of emerging price pressures, while unwelcome, is unlikely to rattle the RBNZ. Six months ago they were projecting a substantial easing in domestic inflation pressures, but their thinking has moved on - in the March Monetary Policy Statement they forecast annual non-tradables inflation to return above 3% from mid-2011 (and that's without the impact of the Emissions Trading Scheme). We continue to expect the first OCR hike in June.

While this morning’s Quarterly Survey of Business Opinion (QSBO) was consistent with ongoing economic recovery, in some key respects it was a bit disappointing. It wasn’t that general confidence faltered, or expectations of own activity came off the boil. Indeed they both strengthened from December, in seasonally adjusted terms, thus aligning with our forecasts of strengthening GDP growth this year. It was more the undertones from the QSBO, and its intimations of recent activity, that had us wondering about the strength of the recovery for the moment, and the risks of high hopes continuing to be questioned by reality. These are hardly ingredients for a recovery as strong as New Zealand has typically seen post previous recessions. Indeed, it’s a recovery that’s dragging the chain a bit, according to the latest QSBO, even though expectations remain optimistic. While it can’t be held up as something to put the RBNZ off the June/July start-point it has indicated, the QSBO certainly makes the case for delay, and more information. We’ll stick with June for the meantime, but bear in mind in wouldn’t take much to shift us to July. In the meantime, much will still hinge on the economic information. Will it be strong enough to force the Bank’s hand as early as June?