We were interested in whether the Bank had raised its forecasts in light of the spectacular capex survey that indicated businesses were still planning to raise capital expenditure in 2008/09 by 29 per cent, marked up from the 21 per cent planned increase reported in the previous survey. With business investment representing around 18 per cent of non farm GDP this would make it a huge stretch to achieve the Bank's 2008/09 growth forecast/target of 1.75 per cent – investment alone could contribute 3 to 5 ppts to growth. Moreover, while the rest of the economy contributed nothing to GDP growth in Q2 it would be an equally huge stretch to expect it to continue doing so over the remainder of the year.
In the event the Bank did adjust its forecast but only to push out the low point in the growth slowdown from December quarter 2008 to March quarter 2009. That was probably more due to the 0.5 per cent rise in non farm GDP in Q2. Following a 0.7 per cent rise in Q1 this meant the last two quarters would need to average 0.15 per cent growth to achieve the original 1.5 per cent target for 2008. Now the next three quarters can average 0.35 per cent to achieve the target.
Nevertheless, the investment survey and associated profit reports highlight how the consumer bears most of the 'responsibility' for delivering and maintaining the RBA's desired slowdown. So far things are on track: Q2 was the weakest quarter for consumers since 1993. However this week's read from the Westpac Consumer Sentiment Index of a rise of 7 per cent following the 9 per cent rise in August would be mildly disturbing. Certainly, sentiment is still 7.5 per cent below the 100 level, indicating that pessimists still outnumber optimists. It has now been in that region for eight consecutive quarters – the longest run since the 1989–91 recession (which saw 57 consecutive quarters).
However we will probably see another rise in sentiment when, as we expect, the Bank cuts rates again on October 7. How much it rebounds is of particular interest for the Bank. Recall that the RBA's decision to reverse course from a clear tightening bias to a rate cut occurred shortly after sentiment hit a 16 year low. We believe the Bank takes the Index very seriously, probably even more so now that the ABS has degraded the other key measure of current consumer activity – monthly retail sales – by reducing its survey sample size by 60 per cent.
Beyond October, we still expect this stage of the easing cycle to have two more cuts by March/April before an extended period when rates are on hold. Those folks who are required to produce rate forecasts over the medium term will be encouraged by the Governor's assessment that when inflation returns to the target band, interest rates can be set at the appropriate level (see discussion below) meaning, presumably neutral (i.e. 5.0–5.5 per cent). Employment will be a key factor in the Bank's medium term thinking.
Here lead indicators are more important than the current data. The ones we favour are now pointing to an employment growth outcome at least as pessimistic as the Bank expects (see discussion below). One of them, our employment sentiment index, continues to point to zero jobs growth despite a 'recovery' in the broader index. That is much weaker than the Bank's core view of a slowing to 0.9 per cent growth and the associated 1 per cent rise in the unemployment rate.
Weakening employment prospects will certainly encourage the Bank to deliver the two extra rate cuts we currently expect, but we recognise that this view may came under threat if the consumer story picks up further.
Bill Evans is chief economist at Westpac Banking Corporation