WEEKEND ECONOMIST: Green shoots

The Westpac-Melbourne Institute Index of Consumer Sentiment increased by 5.2 per cent in November from 99.2 in October to 104.3 in November. This was a surprisingly strong result. The index has reached its highest level since April 2011. After a long 16-month period when the index held below 100 for 14 of those months, we are finally starting to see the Reserve Bank's 150 bps of interest rate cuts have an impact.

However, to put this result into perspective, the index is still only 0.9 per cent above its level of November last year, following the first 25 bp cut from the Reserve Bank. In effect, the subsequent 125 bps of rate cuts have only now really been successful in holding the index at the level reached in November last year.

The survey was conducted from November 5 to 11, so it largely captured the impact on confidence of the Reserve Bank's decision to hold rates steady at its board meeting on November 6, despite extensive speculation in the media that it may cut rates again. It appears that the ‘disappointment' effect of the bank's decision has been quite muted. The more likely explanation for this strong uplift is that households are becoming more comfortable with the global outlook, and are finally responding to the series of rate cuts.

The major negative factor which is likely to have unnerved households is the extensive coverage around the vulnerabilities of Australia's mining boom. We saw some evidence of this in the state results. Confidence fell sharply by 5.2 per cent in Western Australia, the dominant resources state. Sentiment also fell heavily in South Australia (-8.7 per cent), where ongoing disappointment around the cancellation of the Olympic Dam project may be a factor. In contrast to this, confidence surged 14.2 per cent in New South Wales, where mining activity is less significant and (arguably) prospects are brightest for the property market.

Last month we noted that confidence around whether now is a good time to purchase a dwelling had jumped by 9.6 per cent to its highest level since September 2009. In November, the index was unchanged, clearly signalling a boost to confidence around the housing market. Even those folks who hold a mortgage increased their overall confidence reading by 2.9 per cent, despite the likely disappointment from the Reserve Bank's decision.

Other issues that may have impacted confidence over the month were the unemployment rate not increasing, despite extensive media speculation of a weak result, and the decisive Obama victory in the US presidential election. The latter may account for the very sharp 17 per cent jump in sentiment amongst 18-24 year olds, to the highest reading since January 2010.

This long 16-month period where sentiment did not really respond to rate cuts bears comparison with 2008/09. During that period, the index held below 100 for 16 consecutive months. The Reserve Bank was cutting rates between the eighth and 15th month of that run. Rate cuts finally gained traction in the 17th month, where sentiment jumped 13 per cent. Over the following four months, the index went on to surge by a total of 36 per cent. However, a number of other factors contributed to that boost to confidence including: official recognition that "Australia had avoided recession; an aggressive fiscal stimulus both domestically and offshore; and a competitive Australian dollar". It is too early to assess whether the signal from today's print may be comparable given the absence of those other supportive factors in this cycle.

All components of the Index increased in November: the subindexes tracking: views on "family finances vs a year ago" increased by 11.1 per cent; views on "expected family finances over the next 12 months " increased by 1.3 per cent; views on "economic conditions over the next 12 months" increased by 6 per cent; and views on "economic conditions over the next 5 years" increased by 3.4 per cent; while the sub-index tracking responses to "whether now is a good time to purchase a major household item" increased by 5.1 per cent.

As discussed, the overall index is only 0.9 per cent above its level from a year ago, despite 125 bps in rate cuts from the Reserve Bank. However, these cuts are having a more positive impact on households' assessments of their own financial position and their spending intentions. The sub-indexes on "family finances vs a year ago" and "family finances over the next 12 months" are up by 5 per cent and 2.9 per cent respectively, while "time to buy a major household item" is up by 7.6 per cent. Possibly because of the run of disturbing news in the global economy and the deteriorating outlook for mining, the 12-month and five-year economic outlooks are actually down on their year ago levels by 5.7 per cent and 6.1 per cent respectively.

With households more confident around their finances and more positive around their spending intentions than last year, the November result should be of some comfort to retailers that the critical Christmas spending period will show some improvement on last year.

This observation is also supported by responses to the question on whether now is a good time to purchase a car. That index rose by 2.3 per cent in the month to be 14.1 per cent above its level from a year ago, and at its highest level since January 2011.

The Westpac-Melbourne Institute unemployment expectations index fell 6.9 per cent in November following a 1.7 per cent decline in October. However, the index is still up 9.7 per cent over the past year, and the current level is 17 per cent higher than its long run average. The current level of unemployment expectations suggests there should be a much larger rise in the unemployment rate, more in line with the GFC period than the current modest rise. If it were not for a decline in the participation rate, the unemployment rate would now be around 6 per cent rather than the current 5.4 per cent.

The Reserve Bank board next meets on December 4. The governor has signalled in recent statements that the board is open to cutting interest rates further. That is with a clear strategy in mind to improve demand conditions in the economy to compensate for a sharper than originally expected slowdown in the mining sector. The sentiment report indicates that we are finally seeing some traction on confidence from the rate cuts over the last year. But this is not yet convincing, with the index still only 0.9 per cent above last year's level. With private rates still comfortably above the levels of recent easing cycles, it would be unfortunate if the bank becomes over-optimistic to the first convincing sign that its policies are gaining traction.

The Australian economy is facing uncertainty around the mining sector, and with contractionary fiscal policy and a punishingly high Australian dollar, we need further rate cuts to help build on these early signs that lower rates are having an impact on households' confidence.

For these reasons, we expect that the best policy is for the Bank to decide to cut rates again by 25 bps on December 4.

Bill Evans is chief economist at Westpac.