New Zealand businesses were more optimistic about the state of the economy and their own activity in the September quarter, even as their profits were squeezed by rising costs and an inability to hike prices.

A seasonally adjusted net 26 per cent of firms surveyed in the New Zealand Institute of Economic Research's quarterly survey of business opinion expect general business to improve, up from a net 19 per cent in June. A net 26 per cent experienced stronger trading activity in the past three months and 32 per cent see more expansion in the coming quarter, up from 22 per cent on both measures in June.

That upbeat outlook was in spite of a net 1 pe rcent experiencing declining profits in the previous quarter as a net 21 percent of respondents faced higher costs and a net 4 per cent had to lower prices. Still, firms remain optimistic with a net 20 per cent predicting higher profits in the coming period, up from 16 per cent in June, even with a net 23 per cent expecting increased costs and 7 per cent hoping to raise prices.

"Although there was a further lift in confidence in the services sector and firms continue to report high levels of demand, profitability deteriorated over the past quarter," NZIER said in the QSBO report. "This reflected firms' increased difficulty in passing on rising costs, particularly in financial services."


New Zealand's economic activity has been underpinned by a construction sector buoyed by the Canterbury rebuild and Auckland's housing shortage, and record inflows of tourists and net migration supporting consumer demand.

The survey of 925 firms doesn't directly cover agriculture, but showed increased confidence across most regions, with the recent hike to the forecast payout to dairy farmers underpinning gains in rural areas. A net 25 per cent of South Island firms predict good times ahead, up from 12 per cent in June, while Upper North Island business confidence improved 2 per centage points to 26 per cent, and Lower North Island business confidence rose 3 per centage points to 19 per cent.

Principal economist Christina Leung said NZIER expects annual economic growth of 3.5 per cent in the current year, before moderating to an annual 3 per cent pace over the next five years. In the June quarter, Leung had been expecting annual growth of 3 pe rcent this year, slowing to 2.8 per cent thereafter.

Construction remained the most upbeat sector with the country's strong pipeline of residential and commercial work, and architects reporting strong growth in demand for their services.

Retail was one of the few sectors to increase profitability, with cost pressures easing and merchants able to raise prices in the period.

That outlook gave firms confidence in taking on new staff, with a net 27 per cent of firms expecting to hire in the next quarter, though only a net 4 per cent managed to increase headcount in the previous three months. While firms want to take on new staff, they're still finding it hard to find workers, with a net 41 per cent saying it was difficult to get skilled labour and a net 14 per cent struggling to hire unskilled labour.

"Firms report increased difficulty in finding labour, and this may have limited the extent to which firms could increase headcount over the past quarter," Leung said. "The difficulty in finding labour is particularly acute for skilled labour, with shortages at levels not seen since December 2007."

Leung said the limited ability of firms to raise prices meant inflation would probably stay subdued for the rest of 2016, and a net 37 per cent of financial services firms expect lower interest rates in the coming year.

"We do expect an OCR (official cash rate) cut in November and another one some time in the middle of next year," Leung said. "We expect the OCR to trough at 1.5 percent."

Investment intentions were steady, with a net 17 per cent looking to buy new plant and machinery, and 9 per cent expecting to invest in new buildings.