The National Australia Bank says that the sharp drop in activity experienced by the Australian economy last month was “unexpected and significant”. As a result the bank now believes this slumping level of activity will continue in coming months.

In its monthly survey of business conditions and prospects for June, the bank said:

The important macroeconomic message from Nab’s Survey is that conditions across the non-farm business sector as a whole deteriorated unexpectedly and significantly in June and this slowdown in conditions appears to have further to run.

More specifically, growth in both sales and profits moderated significantly further in June, jobs were shed for the first time in over six years, capacity utilization stayed lower, while forward orders remained subdued and negative near term confidence turned more pessimistic. Purchase cost pressures intensified & current inflation edged higher.

The survey shows that business confidence and conditions are now at their lowest since the aftermath of September 11, 2001.

But even though inflation is continuing to edge up, driven by higher oil costs, wages remain steady. The NAB doesn’t expect the Reserve Bank to lift interest rates for the rest of this year, even though inflation will continue to rise over the course of the year. It sees the next RBA rate move as being a cut next year when inflation starts easing. The NAB sees the slowdown being concentrated in the consuming sectors, which is where the Reserve Bank’s attack on inflation is being directed.

NAB said that business conditions deteriorated in June with a “sustained slowdown in sales and profits begins to slow job gains and lower capacity usage. Near term negative confidence weakened significantly further & forward orders were subdued.”

Further, the bank said the survey implies domestic demand up 2.5% to 3% in the year to June, slower than most forecasts. Economy-wide purchase costs are rising, while current inflation is edging higher.

“Business conditions fell by 7 points to an index of nil in June — 20 points lower than its recent peak in October 2007, trading conditions & profits deteriorated by 11 & 4 points, respectively, both to an index point. After a monthly fall of 4 points, employment fell 7 to -2 points — its first negative monthly reading in over six years.

“Conditions were weaker across most industries, while durable retailing & personal & rec. sectors reported poorest conditions. Firms highlight that lower customer confidence & higher interest rates are main drivers of weaker sales.

“Confidence down by 5 points to -9 index points in June — the lowest level since the temporary fall associated with September 11, 2001. Confidence was lower in most sectors to remain at poor levels except in mining. Forward orders remained negative at -3 points — with weak retail orders and to a lesser extent elsewhere partly offset by strong mining orders.

“Reflecting these sustained weaker results, capacity utilisation is now much lower than in early 2008/late 2007 — albeit broadly unchanged at 82.5% in June.

“Annual wages growth was 5.3% in June — largely unchanged during 2008 to date.

“In contrast, purchase costs continued to accelerate to be up 5.2% during 07/08. Economy-wide & retail prices have also picked up – albeit to a lesser extent than costs — to be both up at about 3% during 07/08. Nab’s Survey measure of retail prices and modelling point to another relatively high core CPI outcome of 0.9% in Q2.

“Core inflation forecasts are also unchanged — with core inflation remaining around 4% through most of 2008, before easing back into the RBA’s range during 2009.Headline CPI remains higher due to higher oil, food, rent & financial prices.

“The RBA will look through the adverse near term inflation outlook, but remain alert to any signs of second round effects on wages outcomes. NAB’s medium term forecasts (and judgment that the risks are to the downside) suggest that the RBA will remain on hold at the current tight stance, before lowering the cash rate during 2009.”