Economic outlook dampens

The risk of more interest rate rises this year has receded further. The latest quarterly survey of business opinion provides ample evidence that the economy is slowing nicely - from the Reserve Bank's point of view - and for the right reasons.

The New Zealand Institute of Economic Research's survey, closely watched by the central bank, recorded a further drop in businesses' overall sentiment.

A net 34 per cent in the second quarter survey expect the general business climate to worsen over the next six months, compared with a net 28 per cent in March.

The only sectors and regions not to become more pessimistic were those already deeply gloomy.

What firms are saying about their own trading activity - a more reliable indicator of economic conditions - has also taken a turn for the worse.

Although a net 8 per cent, seasonally adjusted, are still reporting increased activity, that is the weakest this measure has been in nearly five years.

Indeed, among manufacturers a net 5 per cent reported a decline in output in the past three months, the first contraction in six years.

Consistent with firms' reports of declining activity and weaker expectations for output, exports and profitability, pressures on the inflation front are easing too.

However, inflation pressures remain at high levels.

Capacity utilisation - a measure of how close firms are to running plant and machinery flat out - is at 92 per cent, only fractionally below the all-time high of 93 per cent recorded in the second half of last year.

Most firms said they intended to invest more in plant and machinery than they had over the past 12 months.

The level of investment intentions is high compared with the average over the past 10 years.

"Expansion of capacity at this stage of the economic cycle is encouraging. It will help keep growth on an even keel over the next two or three years and help offset inflationary pressures," the institute said.

There has been a sharp fall in firms reporting increased difficulties in finding skilled and unskilled labour. Hiring intentions have weakened but remain at historically strong levels.

Cost pressures are expected to increase, but intentions to raise prices have become less widespread.

Instead margins are being squeezed, with most firms expecting weaker profitability over the next three months. Institute economist Grant Andrews said the economy was clearly in a down phase, but it followed the second or third strongest growth phase in the post-war period.

That had left resources such as labour stretched, creating the uncomfortable combination of weakening domestic demand but cost and price pressures that were still high.

"This could see interest rates staying high," he said.

However, despite domestic demand growth heading on a downwards trajectory, the institute is not forecasting a recession.

"Our view is this survey is indicating the Reserve Bank doesn't need to make any move on interest rates in the next few months," Andrews said.

"But the bank might be nervous because while things are moving in the right direction, they are not moving all that quickly."

In addition to continued capacity constraints, energy-related costs were rising and the impact of the dollar's recent fall had yet to be felt.

Bank of New Zealand economist Stephen Toplis said the survey revealed for the first time a slowdown driven not just by supply constraints - the physical inability to keep pace with demand - but by weakening demand.