Cheer up, mate

Interest rate cuts haven’t fixed sinking business confidence. So what now?

Business confidence is at its worst level since the financial crisis and interest rate cuts aren’t doing the job. The government needs to step up, writes Kiwibank chief economist Jarrod Kerr.

Business confidence is crumbling. In two surveys out this week firms have highlighted weak demand, capacity constraints, government policy uncertainty, and poor pricing power as reasons to be worried. They are concerned about profitability, reducing their intentions to invest, and lower inflation.

All of the above point to economic growth running at around 1%, half the current run rate and a third of what we need. This deterioration in business intentions demands a policy response. We will get a monetary policy response, but what we really need is fiscal stimulus.

Yet the government continues to lie in wait through fear of breaking fiscal responsibility rules that have proven irresponsible. So, we must expect the Reserve Bank (RBNZ) to do more, with diminishing returns.

We now expect the RBNZ to cut the official cash rate (OCR) to just 0.5%, and we see a good chance the bank will deliver this in just one move in November. The risk of a further move to 0.25%, as bank capital requirements bite, is now uncomfortably high and will hurt savers.

The release of both the ANZ Business Outlook survey for September and NZIER’s Quarterly Survey of Business Opinion (QSBO) for the third quarter have disappointed, with both surveys weak and worsening. The surveys differ in their respective respondent groups, but unsurprisingly they are telling us the same thing.

Firms are in a dispirited mood. Business confidence continues to linger around lows last seen during the global financial crisis (GFC). But more concerning is firms’ outlook for their own activity, a leading indicator of economic growth. The outlook has continued to deteriorate and both surveys show that more businesses than not anticipate their activity will fall going into 2020.

For the RBNZ, the forecast pickup in growth over the second half of 2019 may not materialise. A further policy response is likely to be needed to ensure inflation is on track to return to its 2% target mid-point, and we expect it to cut the OCR to 0.75% in November. However there is now a risk that the central bank may go further and deliver a 50-basis point move to 0.5%.

New Zealand business have gone from worrying about policy uncertainty following the last general election, to worrying about weakness in general conditions. Firms are now slowly losing the enthusiasm to hire and invest. Moreover, there is an inability to pass on rising costs to their customers, and this has hammered profitability. Cost increases have come from policy change, such as the large hikes to the minimum wage, but also from capacity constraints and difficulty finding suitable staff – especially in the building industry.

The NZIER survey out today is a story of falling demand both from our trading partners but also at home. A net 11% of firms experienced a fall in trading activity over the third quarter, the lowest level in nine years. NZIER points out that this indicates annual growth of only 1% – well below the 2.1% year-on-year recorded in the second quarter, which was already well below New Zealand’s trend of 2.75%.

Weakness in demand is evident across industries and regions. There were a few glimmers of hope in the survey – but only glimmers. The outlook for domestic trading activity did improve from -4 to 0, and a net 11% of firms are looking to expand headcount next quarter. But we’ve been here before. A more optimistic outlook gets snuffed out by reality.

Today’s QSBO contains several pieces of evidence to suggest that there is spare capacity out there, meaning more policy stimulus is needed to get inflation back on target. Capacity utilisation pulled back a touch in the quarter, cost pressures eased, and firms found it slightly less difficult to find staff – particularly non-skilled staff. All this indicates less inflation pressure, not what the RBNZ would want to see.

We had assigned an uncomfortably high 40% probability of the RBNZ cutting the OCR to just 0.5%.  This week’s confidence surveys have tipped us over the line. In our view there is now a 60-70% chance of a cut to 0.5%, and we have assigned another uncomfortably high 40% probability of a drop to 0.25% in early 2020.

Reserve Bank action has failed to spark the fire needed under business intentions, and more work is required. The protracted and worsening malaise among business is likely to induce another RBNZ response, but it is the government that really needs to step up.

Jarrod Kerr is the chief economist at Kiwibank.

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