Interest rate cut more likely after gloomy survey

1:45PM Tuesday July 08, 2008
By Chris Daniels

Stagflation, that ugly word combining the ugly combination of economic stagnation and high inflation, is afoot in New Zealand, confirmed by this morning's release of an influential business survey.

The New Zealand Institute of Economic Research (NZIER) has just published its Quarterly Survey of Business Opinion for the June 2008 quarter. Some see its research as strengthening the case for an official interest rate cut later this month.

The survey comes as Finance Minister Michael Cullen warned that New Zealanders shouldn't "talk themselves into something far worse than it is", after Treasury confirmed the economy could already be in recession.

The NZIER report shows a "picture of negative economic growth and strong, persistent inflationary pressures" - stagflation underway. This research - which looks ahead to what business plans to do over the next few months - is an important factor when it comes to the Reserve Bank making its decision on official interest rates.

Statistics New Zealand recently reported that Gross Domestic Product (GDP) fell by 0.3 per cent in the March 2008 quarter.

"Indicators of domestic trading activity from the latest QSBO suggest economic activity declined further in the June quarter and is likely to decline again in the September quarter which will make it three quarters of negative economic growth in a row," says the NZIER.

On a seasonally adjusted basis, the survey showed a net 18 per cent of firms reported a decline in their own activity and a net 18 per cent expect their trading activity to fall in the next three months.

"These figures are at their most negative since June 1998 and December 1982, respectively."

While economic activity is clearing falling, inflation pressure is still strong, says the survey.

"While there has been a notable easing in the difficulty finding labour, other indicators of inflation (capacity utilisation, pricing and cost experiences and intentions) suggest that strong inflationary pressures will persist, which will increase the Reserve Banks discomfort in relation to pricing intentions and inflationary expectations."

It's not all bad news in the survey though. Although indicators of activity dropped sharply in the latest survey, indicators of confidence about the general business situation improved slightly.

"They remain near low levels compared with historical experience, however.

On a seasonally adjusted basis, a net 54 per cent of firms expect the general business situation to deteriorate in the next six months. This compares with a net balance of 56 per cent of firms which expected a deteriorating business situation in the March survey. The 56 per cent figure was the highest expecting deterioration since December 2005."

On the employment front, a net 6 per cent of firms intend to decrease staff over the next three months, compared with a net 3 per cent of firms that actually decreased staff in the past three months.

Finance Minister Michael Cullen says there was nothing surprising in last night's Treasury report which said the economy could already be in a recession.

"We're talking about an economy that's running pretty flat," he told reporters today as he went into an all day caucus meeting to plan election strategy.

"That's exactly the forecast we made in the budget, it was the forecast in the last Reserve Bank statement and it's what I told you some months ago."

The Treasury report said the past month had seen the release of data that confirmed a sharp slowing of growth in early 2008 and pointed to further weakness in the June quarter.

"It is possible that the economy has experienced a technical recession in the first half of 2008," the Treasury said.

A technical recession is a decline in GDP for two consecutive quarters.
Cullen said the situation wasn't surprising because of the international environment.

Oil prices were continuing to rise and upsets in the US financial markets were continuing to flow through.

"A number of European countries are clearly moving into recession ... all of those situations say the international environment is one which isn't very favourable," Cullen said.

"We need to get on in this country and not talk ourselves into something far worse than it is. We're talking about a fairly modest bottoming out, certainly no worse than in 1998 and 1999."

Asked whether he was going to do anything to stimulate the economy, Dr Cullen said the tax cuts that take effect on October 1 would deliver "a massive infusion" of spending power into the economy.

"Well over 1 per cent of GDP in one fell swoop, and then rising."

Cullen said the construction sector might soon have capacity to spare, and that might give the Government the opportunity to think about whether it could be more expansive in promoting housing development over the next two or three years.

"I won't go into any more detail than that. I'm simply saying that in the past we've been heavily constrained by capacity in that sector and we're obviously moving to a situation where there may well be spare capacity in that sector," he said.

Chief economist at ASB Bank, Nick Tuffley yesterday said the "QSBO" survey received "very close attention" from the Reserve Bank, as the details gave a lot of insight into both short-term activity trends as well as how the ground is shifting on the inflation front.

ASB economist Nick Tuffley said the QSBO survey "points to the growing dichotomy between the short-term growth and inflation outlooks".

The extent to which key activity indicators have fallen puts them on similar footing to the recessions of 1982, 1991 and 1998. The implications are pretty stark: GDP is likely to register further weakness in 2008 - and more so than the RBNZ factored into its June Monetary Policy Statement."

There were some mixed messages on the inflation front, said Tuffley, but overall the Reserve Bank "should take some heart".

Today's news increased the chances of the Reserve Bank Governor Alan Bollard cutting the Official Cash Rate (OCR) later this month.

"All up the QSBO survey reinforces the case for OCR cuts, and the market is now putting greater weight on a July cut. We judge that the risk of a July OCR cut has grown considerably and that it will be a close call for the RBNZ. For now we are maintaining our view that the RBNZ will wait until September," said Tuffley


Inflation figures are due out next Tuesday, July 15. Reserve Bank Governor Alan Bollard is due to announce whether he will make any change to the Official Cash Rate on Thursday, July 24.

- ADDITIONAL REPORTING NZPA