New Zealand firms pared back their level of optimism in the first three months of the year as domestic trading activity stayed robust while signalling broader price hikes were on the cards as firms contend with an increasingly tight labour market and rising costs.

A seasonally adjusted net 16 per cent of firms surveyed in the New Zealand Institute of Economic Research's quarterly survey of business opinion anticipate better economic conditions in the coming year, down from a net 26 per cent in the December quarter. A net 21 per cent experienced stronger trading in the first three months of 2017 and 25 per cent are picking more expansion to come, both unchanged from the prior period.

Firms experienced an improvement in earnings, with a net 2 per cent showing better profitability in the March quarter, compared to a net zero reading in December, and a net 8 per cent expect that to persist in the coming quarter.

A net 15 per cent of companies surveyed raised prices in the period, and a net 29 per cent expect to do so in the coming quarter.

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"Despite the drop in business confidence, when it comes to own activity, indicators are still holding up at reasonable levels," NZIER senior economist Christina Leung told a briefing in Wellington.

"There was a further lift in inflation pressures across pricing indicators and as capacity utilisation grows."

Inflation returned to the Reserve Bank's target band of 1-to-3 per cent in the December quarter after an extended period of soggy price increases as low interest rates, a strong currency and weak oil prices kept a lid on consumer prices, while at the same time New Zealand's record net migration expanded the labour force and limited wage increases.

Firms continued to struggle to find labour in the March quarter, with a net 41 per cent finding it hard to find skilled workers and a net 24 per cent struggling with unskilled staff, compared to 36 per cent for skilled hires and 24 per cent for unskilled in December. A net 13 per cent of firms took on more staff in the March period and a net 8 per cent expect to hire in the coming three months, down from 14 per cent and 17 per cent in December.

Despite the drop in business confidence, when it comes to own activity, indicators are still holding up at reasonable levels.

Capacity utilisation rose to a record high 93.6 per cent from 92.6 per cent in December, which Leung said was underpinned by the building sector. Construction remained one of the most optimistic sectors and while it faces increased capacity constraints, Leung said building firms were finding it easier to attract unskilled labour, more so than in other sectors.

Construction activity is expected to remain high through the rest of 2017 and is seen as a cornerstone of the country's economy, although architects noted a decline in the pipeline of government work.

Firms scaled back their investment intentions for buildings with a net 8 per cent in the coming year, down from 11 per cent, however a net 18 per cent expect to invest in plant and machinery compared to 16 per cent in December.

Costs remained a concern for firms, with a net 23 per cent experiencing higher costs in March compared to 20 per cent in December, and a net 29 per cent anticipating a larger expense bill in the coming quarter, compared to 18 per cent in the prior period.

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Financial services firms surveyed are seeing a greater chance of an interest rate hike in the coming year, with a net 68 per cent seeing a hike compared to 55 per cent in December. NZIER's Leung still expects the Reserve Bank will raise the official cash rate in the middle of next year, ahead of the central bank's outlook for rates.