Business investment was expected to contract sharply in the near-term, according to a special Treasury report released yesterday.
In its December update, Treasury forecast business investment to decline by 15% in the year to March 2010 and by 24% in the down-side scenario.
In keeping with recent predictions, Treasury has now updated its forecast.
The Government's accounts for the seven months ended January are due for release on Friday.
"Business investment was weaker than we expected in the September quarter 2008, and we now expect it to follow a path similar to the down-side scenario," Treasury said.
Investment was an important driver of both short-term GDP fluctuations and the economy's long-run growth potential.
Treasury said the main determinants of business investment were current and expected demand for a firm's products.
The latest quarterly survey of business opinion showed that business confidence and firms' activity in the December 2008 quarter, and their expectations for the March 2009 quarter, were all at their lowest levels, in seasonally-adjusted terms, since at least 1970.
The weak outlook for activity, combined with limited ability to pass on large input cost increases because of the weak demand, led to expectation of profitability falling to its lowest level in 26 years.
As a result, intentions to invest in plant and machinery fell to their lowest levels since 1975.
Treasury said the cost and availability of finance were also relevant to investment decisions.
Recent falls in interest rates had made it cheaper for New Zealand businesses to borrow, but the reduced availability of credit and tighter lending criteria might restrict credit growth.
"Lower interest rates may encourage some firms to invest.
For others, they are unlikely to outweigh the weak demand they face."
The special report was part of Treasury's monthly economic indicators, which said the outlook for both the world economy and the New Zealand economy continued to deteriorate in February.
"The economy continues to show typical signs of a downturn, with labour markets following declines in other economic indicators.
The unemployment rate increased to 4.6% in the December quarter, as more people joined the labour force and labour demand fell."
Surveys showing that employment intentions by firms were at or near record lows across many sectors indicated that the unemployment rate was likely to increase further, Treasury said.
The number of people employed in the December quarter increased by 0.9%, with most of the increase due to a 3.5% increase in part-time employment.
That suggested firms were responding to the slowdown by having staff work fewer hours or less overtime rather than with layoffs.
Despite the overall increase in employment, there was great variation by age and industry.
On an annual basis, employment increased for those aged 65 and over and decreased significantly for those aged 15 to 19.
"This is another indicator that the labour market is weakening as typically, those with limited labour market experience find it harder to find jobs in a downturn," Treasury said.
The increase in the participation rate showed that more people wanted to work, partly in response to the downturn in the economy.
A fall in labour demand led to an increase in the unemployment rate.
Westpac chief economist Brendan O'Donovan said it was telling that businesses had yet to see any improvement in conditions despite another large 1.5% cut in the official cash rate by the Reserve Bank in January.
"The New Zealand economy has already had to endure a domestically-driven recession and now faces the worst global slowdown in decades," he said.
Labour-hoarding and reshuffling of staff by businesses had reached its limit; businesses were now looking at ways to make cutbacks, he said.
More stimulus was needed, and Mr O'Donovan continued his call for another 1% OCR cut on March 12, taking it down to 2.5%.
