OCR stays at 2.5 percent. Whats next? :

By Hayes Knight – 2 August 2011

As expected the Reserve Bank have kept the OCR at 2.5%, but have given a very strong indication that they will lift the rate soon. So what’s been happening in the market and what can we expect?

Our observations:

  • The banks are still playing hard-ball and are finding it easier to lend on the housing market (existing, not new builds) than they are prepared to lend to businesses, which is a shame as this is the cash generator of our economy.
  • Cash collections are pushing out (increase in debtors days), this in turn is putting strain on working capital.
  • The drop in personal tax rates hasn’t resulted in the higher incomes from business owners being spent in the consumer market. This is because these additional funds have been required to support working capital at a time when bank lending has been hard to source.
  • Retaining profits by way of shrinking overheads whilst their top line has been falling is now a dead strategy for many businesses who are treading the waters of survival. Essentially there’s no more ‘fat’ to cut out and basic company resources are starting to become thin. Many businesses have not proactively invested in Marketing, Training or HR over the past 3 years and this is now starting to bite.
  • Instead, business owners are turning to creating efficiencies in their ‘Cost of Goods Sold’ process to grow Gross Margin/Profit. This has been by way of investing into new technology or by creating a more efficient workforce, particularly in the service sectors.
  • Price discounting has meant the foray into production efficiencies (above) has become a critical and ‘normal way’ to do business.
  • Increased employment opportunities are back on the table as demand for capacity starts to increase following what has been a shrinking labour market over the past 3 years. Some fish hooks in this include owners looking for readily skilled staff in order to retain operating efficiencies (i.e. they don’t want to invest too heavily in training to get new employees up to speed). There appears to be a lack of skills and work experience in many of the applicants which has been a road block to filling many job vacancies.
  • Capital expenditure and R&D is back as owners look for new ways to increase efficiencies and revolutionise their business offerings. The banks are very cautious and adverse in their lending to new and unproven technologies which is making these proactive strategies difficult to implement. Owners are now researching how they can obtain access to Government R&D Grants.
  • Spending on IT remains high.
  • Baby boomers are starting to recognise the “succession problem” and are looking for new exit plans which are able to fund deals without full reliance on a buyer’s banking support.
  • We expect to see a roll-up of many businesses in the short to medium term as businesses amalgamate to form a stronger business model. This may be critical in the Professional Services sector (e.g. Lawyers, Accountants, Architects and the Medical Sector) as high level technical resources become harder to source and the more efficient business models can support a greater output from its primary production line (i.e. the components of Gross Profit).

What has the Reserve Bank indicated?

  • There is definitely a sign that robust confidence is back in the market. However this hasn’t yet transpired into businesses experiencing an increase in sales turnover.
  • Auckland is leading the charge in the business-to-business market. However, Auckland’s retail sector is lagging behind the rest of the country. The increased price in the likes of sales from meat and dairy products will take a lot longer to flow out of the rural sector and into the urban centres.
  • Inflation is still reasonably low. However, this may be impacted from a high New Zealand dollar. It is unsure yet whether any increase in inflation is primarily down to the increase in petrol prices and the food price index.
  • The impact of our high New Zealand dollar has meant exporters are setting up subsidiaries overseas and trading from there, retaining profits in those countries, rather than exporting to those markets.
  • There has been very little flow on effect from the Government spend on the Christchurch earthquakes into our economy.

What’s next?

The OCR will probably need to be held until confidence starts to flow through to actual trading results. Our pick is that we can start to see a lift in the OCR from September, and that it will initially be the reversal of the “temporary” cut from March of 50 basis points or .5% which was put in place due to the devastation in Christchurch and the impact on the national economy that the disaster has had. From there, we would expect some steady rises as the Reserve Bank attempts to stem domestic demand and keep inflation under control. 

Looking at the fixed rates on offer by the banks, the longer term rates appear to have already factored some increases in to them. The 18 month and 24 month rates are looking pretty good right now.

To find out what Hayes Knight can do for your business contact your Hayes Knight Business Advisor.