Weekend Economist: A confidence blow

A soft labour market and a dip in consumer sentiment will cloud the government's Mid-Year Economic and Fiscal Outlook, which will test an already-fragile confidence in the economy further.

This week we saw some convincing evidence around the fragility of confidence in this economy. Next week, with the release of the government's Mid-Year Economic and Fiscal Outlook, we are likely to see confidence tested further.

The Westpac Melbourne Institute Index of Consumer Sentiment fell by 4.8 per cent in December, from 110.3 in November to 105.0 in December. This is the lowest level of the Index since July this year. It is 4.3 per cent below the average print for the last 3 months, which covered the post-election period and the time of most euphoria around house prices.

It appears that the boost in confidence partly associated with the election result and booming house prices has faded. In particular, confidence around the economic outlook has faltered.

The components of the Index measuring consumer views on the economic outlook over the next 12 months and five years are both down by over 10 per cent from their average reads over the last three months.

The news is no better around the labour market. More consumers expect unemployment to rise with the Westpac Melbourne Institute Unemployment Expectations Index increasing by 4.6 per cent from 144.7 to 151.4. This measure provides an indication of how secure respondents feel in their jobs.

The Index is 5.4 per cent above the average read of the last three months and remains 6.3 per cent above its level in October 2011, despite 225 basis points in rate cuts by the Reserve Bank. That compares to the Consumer Confidence Index, which is 8 per cent above its October 2011 level.

One potential offset to how households might feel about their job security is hours worked. To October, the Bureau of Statistics Employment Report showed that hours worked had increased by 2 per cent over the year compared to the very disappointing 0.8 per cent increase in total employment indicating that those people with jobs were working more hours, potentially improving their feelings of job security.

However, the November report (which printed on December 12) showed a marked fall in hours worked (–0.7 per cent), pushing annual growth back to 0.4 per cent – in line with total employment growth of 0.8 per cent (–0.5 per cent full time; 3.7 per cent part time).

There is no longer a gap between employment growth and hours worked, deflating any expectations that workers might feel more secure due to working longer hours.

 We also received information on respondents’ most widely recalled news items in December. The highest recall this month was on items about economic conditions; budget and taxation; interest rates and employment. Relative to September, when we last surveyed consumers’ news recall, respondents assessed news to be significantly more unfavourable around employment (85 per cent unfavourable; 15 per cent favourable); budget and taxation (75 per cent unfavourable; 25 per cent favourable); and interest rates (60 per cent unfavourable; 40 per cent favourable compared to 60 per cent favourable; 40 per cent unfavourable in September).

It is likely that news on job losses in high-profile companies such as Qantas and Holden may have unnerved respondents, while media coverage of rising fixed mortgage rates may also have been a factor in the sharp swing in assessments of interest rate news from favourable to unfavourable.

The survey was conducted the week before the surprise announcement of the closure of Holden in 2017. An even more severe jolt to confidence can be expected in the next survey.

The news around the housing market is mixed and is probably pointing to an affordability constraint impacting the market. The index tracking responses to the question on whether now is a good ‘time to buy a dwelling’ fell by 4.2 per cent in December to be down by 10.5 per cent from its September peak. At the same time, the Westpac Melbourne Institute House Price Expectations Index increased by 1.4 per cent to be up by 14 per cent over the last five months.

The mix suggests an affordability issue (rather than the expectation of falling prices) and is most apparent in New South Wales, where prices have increased the fastest. The index tracking NSW responses to ‘time to buy a dwelling’ plummeted 13 per cent in December to be down 21.9 per cent from its September peak, while the state measure of house price expectations is up by 20 per cent.

Surveys around business confidence were mixed. The NAB survey across all industries showed confidence and conditions for November were largely unchanged from the October readings. One disturbing aspect to the survey was a sharp fall in employment plans, with that metric significantly below average levels of previous months.

On the other hand, the Westpac–ACCI survey of manufacturing showed a marked improvement in conditions, confidence and employment intentions, partly reflecting an uplift in building materials. Both business and consumer confidence are likely to be tested next week when the government releases its Mid-Year Economic and Fiscal Outlook.

We have prepared a separate detailed preview of this document. Key highlights are expected to include: a downgrade in nominal GDP growth forecasts in 2013/14 and 2014/15; an uplift in the forecast unemployment rate, with the rate expected to drift higher from the current expected peak of 6.25 per cent; an increase in the forecast cumulative deficit over the next four years from $54.5 billion to $103 billion, pushing the gross debt up from $370 billion to $420 billion by 2016/17; an analysis of the likely fiscal drift beyond the four-year forecast period, pushing gross debt out to $500 billion over that period; and no specific date for a return to surplus, although rhetoric is likely to aim at a surplus over that 10-year projection period.

That MYEFO is likely to provide a sufficiently worrying fiscal picture to support the government's consolidation policies, which will be released at Budget time. Of course, none of these developments appear to have swayed the Reserve Bank from its clear strategy of recognising the need for stimulus, but preferring to pursue the policy through the Australian dollar.

The governor's stated preference to have the Australian dollar nearer to $US0.85 is proving to be effective, given its recent retreat from $US0.91 to $US0.89. Success will depend on whether the US Federal Reserve decides to ‘taper’ its quantitative easing policy. That decision will be revealed at the Federal Open Market Committee meeting next week. We expect no taper.

The governor's aversion to cutting rates will be further assessed in his address and Q&A with the House of Representatives' Standing Committee on Economics. That will be the time to review our current interest rate forecasts, as it will be sufficiently close to the next Reserve Bank board meeting where monetary policy forecasts are driven more by assessments of the attitudes of the decision-makers than the forecast evolution of the data.

Bill Evans is Westpac’s chief economist.