Dialogue: Confidence dip may set scene for bank action

Economics editor BRIAN FALLOW canvasses the experts' latest views on what Reserve Bank Governor Don Brash will do after Easter.

The prevailing view among market economists is that the Reserve Bank will shave another quarter of a percentage point off interest rates next week.

The plunge in "headline" business confidence recorded in the Institute of Economic Research's latest quarterly survey has tipped the balance of expectations in that direction.

A poll of 16 forecasters by Dow Jones Newswires after news of the confidence drop came out on Tuesday found that five more had moved to predicting a 25 basis point cut next Thursday, bringing the total to nine. Another expects Governor Don Brash to go 50 points next week. The rest are mulling it over.

The dealing rooms, typically, are way ahead of them. Ninety-day bill futures were already pricing in a 50 basis point cut by mid-year and have pushed rates lower still. They see a further 25 points in the September quarter before the interest rate cycle starts to turn up again.

So can we bank on a rate cut next week?

The first point to note is that the financial markets have a tendency to get ahead of themselves. And only a minority of economists predicted Dr Brash's rate cut last month.

The second point is that when he made the cut, Dr Brash emphasised it was a finely balanced, eleventh-hour decision and was careful not to indicate any further easing bias.

With the dollar close to all-time lows, and continuing strength in the labour market - as evidenced by March's 2.5 per cent growth, month on month, in job ads - concerns about imported inflation and a revival of a wage-price spiral cannot be airily waved aside.

The institute survey's capacity utilisation indicator, a measure of spare capacity in the manufacturing and building sectors, has risen to levels last seen in the second half of 1999, when the economy was doing very nicely thank-you.

But the survey also found evidence of continuing lack of pricing power and an attendant squeeze on firms' margins as the proportion expecting their costs to rise over the next three months outstripped the proportion expecting to raise their own prices.

The proportion of firms reporting that they increased their selling prices over the past three months fell from a net 33 per cent in December to a net 16 per cent, while those expecting to raise prices over the coming quarter fell from 34 to 13 per cent.

Music this may be to the Reserve Bank's ears, but it will wait to see if the full choir is singing the same song, so to speak. The consumers price index comes out next Wednesday, the day before the interest rate verdict is due to be handed down.

The institute survey's steep fall in general confidence, from a net 31 per cent optimistic three months ago to a net 2 per cent pessimistic, is on the face of it at odds with the National Bank's monthly business confidence survey early last month. It showed a net 30 per cent of respondent firms expecting the general business climate to improve over the next six months.

Part of the explanation of the difference between the two surveys may lie in the fact that the National Bank's has a larger exposure to the buoyant farming sector.

The National Bank's chief economist, Brendan O'Donovan, says that early responses to the April survey suggest headline confidence has deteriorated, but only about half as much as in the institute survey.

And firms' expectations about their own activity remain close to their previous, solid level, he says.

It is an important distinction. While business people's views about the general economic outlook can be blown around by the crosswinds of media coverage and haphazard anecdotal evidence about how the other fellow is doing, their views of their own firms' prospects are more authoritative.

In the institute survey, domestic trading expectations, hiring intentions and investment intentions were down but only slightly.

Therefore the sell-off of the kiwi dollar which the confidence figure triggered was, as institute director Alex Sundakov said, an over-reaction. The dollar yesterday recovered most of the lost ground.

Nonetheless, says UBS Warburg chief economist Robin Clements, this partial reversal of the December quarter's surge in business confidence starts to undermine a key element to sustaining overall activity growth as New Zealand's trading partners slow.

The risk is always that weak confidence becomes self-fulfilling, especially if it spreads from business to consumers.

The last WestpacTrust consumer confidence survey was encouraging, but the Colmar Brunton and TV3 polls suggest consumer sentiment has recently softened, too.

Both the Reserve Bank of Australia and the US Federal Reserve have cited weak consumer confidence in justifying rate cuts.

Mr Clements says that, even with a less rosy growth outlook, New Zealand is still likely to outperform its trading partners, while the associated inflation outlook implies less aggressive rate cuts than in the United States or Australia.

Mr O'Donovan says the Reserve Bank still has more work to do to cushion the economy from the global slowdown.

"In our view the downside risks to growth have increased sufficiently for them to lower rates by a further 75 to 100 basis points this year, and to kick this off with a 25 point cut next week."

Salmon Smith Barney economist Annette Beacher says that, based on past correlations between surveyed business confidence and gross domestic product, the recovery in economic growth would stall at around an annual rate of 3 per cent by the end of this year.

Deutsche Bank's Darren Gibbs says indicators of actual activity remain more robust than suggested by the confidence data.

"Retail, housing and employment indicators all suggest that the economy continues to grow at around its trend growth, which we assess as being no more than 2.5 per cent a year."