Inflation concerns knocked by survey

Financial markets think it is close to a sure bet that the Reserve Bank will raise interest rates this month, but the Institute of Economic Research's latest quarterly survey of business opinion provides little fresh prey for the hawks to swoop on.

Companies' responses unambiguously show a slowing economy and, while costs have risen steeply, there is only a small increase in the proportion of firms saying they intend to raise prices.

The institute says the gap between firms reporting higher costs (a net 49 per cent) and those intending to raise their prices (a net 26 per cent) is the widest it has been since the late 1980s.

The gap suggests inflation will not automatically follow from recent cost increases.

Asked if there was any reason for the bank to raise interest rates again, institute economist Grant Andrews said: "Not on the strength of this, no."

A further tightening of the monetary screws risked turning a gradual slowdown into a steep one and might be unnecessary.

The financial markets, however, are confident the bank will raise the official cash rate to 7 per cent on October 26 and see at least an outside chance of a further increase in December. Most market economists share that view.

The institute's survey recorded a slight reduction in the level of pessimism about the general business outlook, to a net 32 per cent of respondents negative compared with a net 34 per cent in June.

The upper North Island is the most pessimistic region. Institute economist John Stephenson said this might reflect some weakening of the wealth effect from housing (where home-owners borrow and spend on the strength of increases in the value of their properties).

The services sector is the most pessimistic.

"Perhaps that is a sign firms relying on the domestic economy are starting to see the slowdown happening," Andrews said.

Domestic trading activity continued to weaken. Only a net 4 per cent of firms reported an increase in their own activity in the past three months, down from 8 per cent in June and 19 per cent in March.

This indicator, which is a pointer to economic growth, is at its lowest level for five years.

The institute said capacity use among manufacturers and builders was unchanged at 92 per cent, but indicators of tightness in the labour market had eased.

Hiring intentions weakened. In June, most industries and regions expected to increase staff numbers; this time most expect little increase or some decline.

Past relationships with these indicators suggest there will still be upward momentum in wages for the next year to 18 months, but that the brow of the hill is in sight.

Fewer firms cited labour as the single factor most restricting their ability to increase turnover.

Instead, the proportion of firms saying a lack of sales or orders is the main constraint continues to rise steadily - evidence that demand is moderating as the Reserve Bank would wish.

But Bank of New Zealand economist Dean Ford said the levels of capacity constraints recorded in the survey, for plant and machinery and for labour, were consistent with non-tradeables inflation holding at or near 4 per cent for much of next year.

"Combine this with the jumps in fuel prices and inflation is likely to remain high for some time yet."