WEEKEND ECONOMIST: Consumer confusion

Retail spending has been surging this year but consumer sentiment has now delivered its sixth negative print in as many months – and it is tracking down. 'One-off' factors may be at play.

The Westpac-Melbourne Institute Index of Consumer Sentiment fell by 2.5 per cent in August, from 99.1 in July to 96.6 in August.

That was a disappointing result. There had been enough positive news around since the last survey, and generally over the last few months, to have sustained an upswing in consumer sentiment.

Consider news that real retail spending grew in the first half of the year at a 5.6 per cent annualised pace and nominal retail spending grew at an 11 per cent annualised pace in May/June; unemployment fell from 5.3 per cent to 5.2 per cent in July; the government released $1.9 billion in fiscal compensation over the May-June period; and the Reserve Bank cut the overnight cash rate by 0.75 per cent in May/June (increasing effective household cash flows by $1.2 billion).

Indicative of a more positive global outlook, the sharemarket had risen by 2.9 per cent and the Australian dollar had risen from around $US1.02 to $US1.05 since the survey in July (the latter also reflecting Australia’s
attractive interest rate differential).

With all those factors, the promising uplift we saw in July of 3.7 per cent was entitled to form a base for a more sustainable upswing.

Rather, the index seems to be settling in a "cautiously pessimistic range". This is the sixth consecutive month that the index has registered below 100, averaging 96.2. This is unusual.

The only comparable periods since the recession of the early 1990s are in 2000-01 when the index printed an average of 96.5 over an eight-month period, and in 2008-09 when it averaged 88.0 over a 16-month period.

That most recent period coincided with the authorities responding with a very aggressive fiscal expansion. In the current period, both federal and state governments are entering into substantial fiscal consolidations.

That is particularly pertinent in Queensland, where the index fell from an already weak 91.7 to 83.0 – a 9.5 per cent fall. Extensive media coverage of likely job losses, particularly in the public service, in Queensland is likely to have unnerved Queenslanders.

While the Reserve Bank did not surprise by holding rates steady at its August board meeting, consumer perceptions of the outlook for interest rates have shifted.

Media reports that the Reserve Bank may have decided against future rate cuts are likely to have unnerved households. For example, despite rates staying on hold, the confidence of respondents who hold a mortgage fell by 3.9 per cent.

That hypothesis was also supported by an 8 per cent reduction in confidence around whether now is a good time to purchase a dwelling.

We also conducted our quarterly survey of interest rate expectations in this survey. This confirmed that assessment, with the proportion of respondents expecting the RBA to cut rates falling from 52.4 per cent in June to 32.5 per cent, in August – a very significant change.

The print for August indicates that pessimists clearly outnumber optimists. The index is only 0.6 per cent above the level in March this year which preceded the most recent rate cuts and the cash disbursements.

The failure of the index to maintain any upswing raises the risk that the strong retail spending which we have seen in the first half of the year might be largely due to aggressive discounting and the one-off boosts to income growth from the fiscal payments and rate cuts (certainly the breakneck 11 per cent annualised pace in May/June points in that direction).

The risk, as indicated by this ongoing under-performance of confidence, is that retail spending loses momentum in the second half of the year.

In that regard, I was interested to hear from a major retailer recently that, while May and June had been very strong, July and August had been very weak. We must be careful in interpreting one-off "anecdotal" evidence, but the absence of those two "one offs" might indicate a consumer story more in line with the message from the index.

Confidence fell in every state except for Victoria (up 3.9 per cent). The sharpest fall was reserved for Queensland, but we also saw soft results in NSW (down 1.8 per cent); WA (down 2.6 per cent); and SA (down 2.8 per cent). There were falls in four of the five components of the index.

The sub-index tracking views on "family finances compared to a year ago" fell by 6.3 per cent whereas the sub-index tracking expectations for finances over the next 12 months increased by 3.3 per cent. The subindexes tracking consumer views on the economic outlook both deteriorated, with the 12-month outlook down 3.1 per cent and the five-year outlook down 2.7 per cent.

The sub-index tracking opinions on "whether now is a good time to buy a major household item" fell by 3.6 per cent. We have been particularly worried about households' assessments of their finances over the next 12 months. It is mildly encouraging that this component has increased by 6.4 per cent over the last two months, likely reflecting the direct boost from fiscal payments and rate cuts, but it is still 7.2 per cent below its read as recently as March.

There was also bad news on the employment outlook front. The Westpac-Melbourne Institute Unemployment Expectations Index rose by 3.8 per cent in August. A higher index level indicates a higher degree of concern around job prospects and job security.

The level of the index is now up 14 per cent over the year and 54 per cent from its previous low in February 2011. This index has had a consistently reliable leading relationship with the unemployment rate and points to a sustained increase in the unemployment rate in the second half of 2012. Critics of the index note that it may be unnecessarily influenced by high profile job losses which attract disproportionate media attention, while job gains in industries such as social or professional services receive little media attention.

However, we also believe that perceptions of job security are formed at the micro level, with respondents reacting to news on the changed circumstances within their own workplace or within the workplaces of friends and family.

Our forecast for the unemployment rate by year's end is around 5.75 per cent, a result which will be reached if jobs growth is insufficient to offset the (around 13,000) monthly natural increase in the labour force.

The Reserve Bank Board next meets on September 4. We do not expect a rate cut. However, despite current media speculation, we do believe that the case for further cuts is likely to be clear by the December quarter.

The critical issues will be around the sustainability of the recent surge in consumer spending; the resilience of the labour market; and developments in Europe.

With fiscal policy consolidating and the Australian dollar likely to remain high, adjustments in monetary policy are likely to be the only policy option available if further assistance is required. Private sector interest rates are only slightly below average levels. There is adequate scope for further monetary assistance.