Firms turn pessimistic in June quarter as economic recovery remains lacklustre, NZIER says; Capacity pressures in Canterbury; OCR on hold 'for some time'

Firms turned pessimistic in the June quarter as New Zealand's economic recovery remained lacklustre, the New Zealand Institute of Economic Research says.

The slow recovery, along with contained inflation pressures, meant the Reserve Bank should be able to keep the Official Cash Rate on hold at 2.5% "for some time." NZIER has been picking the OCR will remain on hold until mid-2013, or perhaps even later, while bank economists are expecting the first move up in the March 2013 quarter.

There was evidence the rebuild in Canterbury was picking up, and capacity pressures in the region's building sector were starting to appear, NZIER said.

Releasing its Quarterly Survey of Business Opinion, NZIER principal economist Shamubeel Eaqub said the survey's confidence measure showed firms became pessimistic (-1% from 21%) but experienced trading activity edged up (1% from 0%) on a seasonally adjusted basis.

"This is consistent with annual economic growth of around 2%," Eaqub said.

“The recovery remains lacklustre. But there is encouraging evidence of a rebound in Canterbury following the earthquakes. The recovery has stagnated in the rest of the country," he said.

“Labour market improvement has stalled outside of Canterbury. This is consistent with modest employment and wage growth."

Weakening inflation

Capacity pressures were emerging in Canterbury, mainly in the building sector, while elsewhere there was excess capacity.

"Price increases are slow. For retailers, prices are falling. Even construction prices are falling outside of Canterbury. Inflation is easing and medium term pressures are subdued," Eaqub said.

"Firms’ profits remain under intense pressure from anaemic sales and razor thin margins. As a result, business investment intentions are soft for this stage of the economic recovery," he said.

"The RBNZ will keep interest rates on hold for some time. The QSBO shows a lacklustre economic recovery and contained inflationary pressures."

Here is the reaction from ASB economist Daniel Smith

The NZIER Quarterly Survey of Business Opinion showed that business confidence has fallen since March 2012. That is not surprising given the escalation of the Eurozone crisis over the last few months, and the survey period of June included the unsettling second Greek election. A similar drop in business confidence was seen in Q4 2011 when the crisis last peaked.

The seasonally-adjusted measure of general business confidence fell to -1 from the result of 21 recorded in March. That means general confidence is roughly back to where it was in December 2011, when the reading was 2. The reading for firms’ own activity level over the next quarter also fell, from 22 to 9. That is the weakest reading since March 2011, when theCanterbury earthquake sent the own activity measure down to 4.

While expectations of future activity have suffered, reports of activity over the last three months remained virtually flat; the reading of firms’ own activity over the last quarter moved from 0 to 1. Profitability over the last quarter was also relatively unchanged, moving from -15 to -13. That suggests that while uncertainty from offshore is damaging confidence, experienced trading activity has not been detrimentally affected.

As expected, results from the Canterbury region continue to be much stronger than those from the rest of the country, particularly regarding hiring and investment intentions. Experienced hiring in Canterbury held up at a strong level, but reportedly softened in the rest of the country. A similar pattern emerged in the Q1 HLFS, and this result implies that the pattern continued through Q2.

Looking across the different sectors monitored, there are one or two noticeable changes from the Q1 survey. Manufacturers reported a strong bounce back in experienced domestic deliveries (up from -25 to +5), which is encouraging following the surprisingly weak reading from Q1. Meanwhile, the building industry seems confident of its future prospects, signalling that rebuilding work is entering the pipeline. New orders and output for builders both increased, while architects reported expectations of more work over the next 12 months across residential, commercial and government projects.

Inflation indicators suggest that pressures remain very subdued. Expected selling prices over the next quarter dropped from 23 to 10, while capacity utilisation ticked up very slightly from 89.4% to 89.8%. Capacity utilisation increased by more in the building sector but average costs and selling prices both softened.

Implications

Business confidence understandably weakened in light of the Eurozone crisis, which has once again returned to the headlines. Confidence is broadly in line with the results from Q4 2011, when the crisis last peaked. Firms’ own activity expectations have also weakened noticeably, but reported activity over the past quarter did not seem to be affected.  We expect soft GDP growth of 0.3% for Q2, but that follows 1.1% growth in Q1.  Business confidence is likely to recover to some degree over Q3 given that the Greek election outcome reduced the uncertainty over whether Greece would remain in the euro that afflicted the first half of June.

Inflation indicators also remain weak on the whole. The most likely source of inflationary pressures over the next few years will be the construction sector in Canterbury. While activity and capacity utilisation there are rising, price expectations remain well contained for now. Therefore, we continue to expect that the RBNZ will leave interest rates on hold until at least March 2013.