Have lower interest rates spooked businesses?

Business confidence has fallen to its lowest level in a decade.

ANZ’s Business Outlook in September showed a net -2% of firms expect their own activity to deteriorate over the year ahead, while a net 25% of respondents expect profitability to decline.

This pessimism is also flowing through into employment and investment intentions.

A net 8% of firms now intend to reduce employment, while a net 9% intend to reduce investment.

The Reserve Bank will be left disappointed that its surprise 50 basis point cut to the official cash rate (OCR) in August has not yet had a positive influence on business sentiment.

The irony is that the Reserve Bank’s August OCR cut, which was much bigger than market expectations, has spooked businesses rather than boosted them as had been intended.

There are also signs that household confidence is subdued.

The ANZ-Roy Morgan Consumer Confidence Index in September fell by four points to 114 – its lowest in four years. Consumers’ perceptions of their current financial situation fell 5 points, with just 11% of households now feeling financially better off than a year ago. Households are also less confident about the future, with only a net 23% of consumers expecting to be better off financially this time next year, down 4 points from August.

But despite the fall, one shouldn’t overstate the weakness in consumer sentiment.

There are still some signs that lower interest rates may be shoring up the proportion of households considering buying a major household item.

Low levels of unemployment may also be supporting these spending intentions. Nevertheless, the recent deterioration to business’ hiring intentions does suggest there could be some labour market vulnerabilities going forward.  These vulnerabilities could detract from consumer spending in 2020.

At this stage there is a strong likelihood that the Reserve Bank will be proactive and cut the OCR again in November.

The Reserve Bank is likely to flag weakened consumer and business sentiment at home, alongside heightened risks of downside surprises from overseas economies as factors behind the decision.

Weakening inflation expectations, in both RBNZ and other business surveys, will also add weight to the case for a cut.

But mortgage holders shouldn’t get too excited – OCR cuts from such a low level are unlikely to have anymore than a marginal effect on mortgage interest rates.

The reality is that the banks source a lot of their money on international markets, where the OCR is irrelevant. And even for domestically-sourced funds, the banks are somewhat constrained.  Banks can’t afford to cut term deposit rates much more or their steady supply of relatively cheaper domestically-sourced bank funding may dry up.