Business Outlook

June 2008

Seeking favourable conditions for germination

Another month has come and gone. The June reading of the National Bank Business Outlook eerily resembles that of May. Business confidence has once again nudged higher. A net 39 percent expect worse times over the year ahead, up from a net 50 percent last month. But when we look at the detail, the move appears to lack conviction, and pricing intentions continue to rise.

The underlying economy remains very weak. Own activity expectations, which provide a better indication of overall economic growth, remain unchanged from last month with a net 4 percent expecting tougher times. This is the fourth successive month firms’ own activity expectations have been negative. Not since 1988 have we seen firms’ own activity expectations remain so consistently weak. We’ve said it before and we’ll say it again. When this indicator is negative, the economy is moving backwards. Employment intentions continue to ebb lower. A net 12 percent expect labour market conditions to worsen. Investment intentions slipped another notch in the month, with a net 3 percent expecting a decline. Collectively, our composite growth indicator from the survey remains in negative territory.

Taking on a more positive tone, we are in no doubt that the seeds of an upswing and the all important realignment in the composition to growth are very slowly being sown. The NZ dollar is starting to correct, although more slowly versus the all important US dollar. If the greenback is going down, we struggle to do the same. The Reserve Bank has moved to an easing bias and rate cuts look to be just around the corner. Fiscal policy is delivering impetus via tax cuts late in the year. But given the combination of global unease, surging oil prices, leverage, and pressure on household budgets from burgeoning food related inflation; the adjustment we are embarking on, and one which we have talked about for some time, will be elongated in nature as the piper is paid.

In many ways the length of the downturn rests in businesses’ hands. Diminished revenue growth and pressure on costs is forcing firms to look more closely at extracting efficiencies and productivity, both pre-cursors to the next cyclical upswing. This is the next leg (and rather painful one to those who have not experienced a rising unemployment rate before) of the economic cycle that New Zealand must embark on. Productivity growth, by definition, requires more output for less input. A muddle through type response will result in a muddle through recovery. A deeper hole may be a prerequisite to climbing out with sustainable vigour.

The New Zealand economy is navigating through three shocks at once: a housing shock, the worst global credit conditions in 50 years, and a commodity price shock. The latter presents a great opportunity (i.e. surging soft commodity prices), but also poses threats in the form of higher inflation. Plotting a path for the economy and guiding it safely through such a myriad of headwinds is a tall order for monetary policy alone. The Reserve Bank has encouragingly signalled a preparedness to look through the temporary spike in inflation, and we expect two to three rate cuts before year end. A July start remains a distinct possibility. But pricing intentions (within a net 41 percent expecting to raise prices) have now risen to the highest reading since 2000, and inflation expectations continue to nudge up. There is a limit as to how far monetary policy reflation can go in a world of inflation.

Help from other areas would also not go astray. Monetary policy has been, and always will be, the primary stabilisation instrument which we rely on in terms of keeping output, employment, and inflation around a longer-term sustainable trend. Yet, moving forward, the global economy is becoming increasingly integrated. Globalisation and the emergence of Asia have brought tremendous benefit to New Zealand in the form of free flows of capital and technology, migration, lower prices for manufactured goods, higher commodity prices, and a centre of economic gravity that is moving closer towards New Zealand. However, there is no free lunch.

Globalisation comes with challenges. We see greater volatility in the currency, capital flows and commodity prices, including oil. The long end of the New Zealand yield curve is heavily influenced by offshore developments. More recently we have seen massive swings in the price of credit.

In a rapidly integrating world, we need to look wider and to other stabilisation mechanisms, particularly when faced with multiple external shocks. This does not mean that monetary policy needs more levers to pull, rather it needs more friends. Indeed, while we have other stabilisation mechanisms such as a freely floating exchange rate and a flexible labour market — both critical components of New Zealand’s economic framework — fiscal policy is typically overlooked. Central government spending is equivalent to a third of GDP. They have the biggest balance sheet in the economy and they control the regulatory framework, a key productivity inhibitor at present. Unlike businesses, Governments do not (or seldom) go broke. Of course, the majority of fiscal policy decisions should be set within a medium-term context.

However, the turn in the economic cycle has been too aggressive and no let up is in sight. Now is not the time for fiscal policy to be idly standing by, leaving it all up to automatic stabilisers.

If you would like to become a respondent to our survey, send an email to economics@nbnz.co.nz with your business location and industry sector. For details on the nature and performance of the Business Outlook on to
www.nationalbank.co.nz/economics/outlook/pdf/BOBackgroundPaper.pdf
This background paper also contains enrolment forms for new survey respondents.

The tables can be viewed as charts on our Business Outlook charts page.

Survey Results

This material is provided as a complimentary service of The National Bank of New Zealand, part of ANZ National Bank Limited ("Bank"). It is prepared based on information and sources the Bank believes to be reliable. Its content is for information only, is subject to change and is not a substitute for commercial judgement or professional advice, which should be sought prior to acting in reliance on it. To the extent permitted by law the Bank disclaims liability or responsibility to any person for any direct or indirect loss or damage that may result from any act or omission by any person in relation to the material.