Markets are pricing a 25 basis point rate hike by November at around 40 per cent probability with a 60 per cent probability of a move by December. Westpac's proprietary research which was released this week has just emphasised the fragility of the current recovery. It highlights the need for the Reserve Bank to delay its next rate hike to early next year to allow the Australian economy to build a more solid foundation for the rebalancing of the growth drivers from the public to the private sector.
Firstly we saw a surprise 5 per cent fall in the Westpac–Melbourne Institute Index of Consumer Sentiment. That fall came despite a fourth consecutive month of steady interest rates and a fall in the unemployment rate from 5.3 per cent to 5.1 per cent. We assessed that the August read of 119.2 for the index was just too high and had been boosted by a relief rally when the Reserve Bank chose not to raise rates in August. Notably, other aspects of the survey indicate that the consumer is still cautious.
This caution is best exemplified by the jump in the proportion of respondents who assess that "pay down debt" is the wisest place for savings from 16.7 per cent in June to 21 per cent in September (up from 10-12 per cent prior to the global financial crisis).
There is also a near record gap between respondents' assessments of the overall economic outlook which is particularly strong and their assessments of their own finances and their spending expectations. There seems to be a strong element of consumers' recognising the buoyant outlook for the economy due to the Mining Boom Mark II but questioning just how that boom is going to directly benefit their own financial position.
In the last two weeks I have spent time with Westpac's customers in both Perth and Brisbane – the two cities most directly affected by the mining boom and even there this concern has been to the fore. The state breakdown of the movements in the Consumer Sentiment Index further highlights that concern. In September we saw a 13.6 per cent fall in the Confidence index for Queensland and a 16.2 per cent fall in the index for Western Australia. Confidence levels in other states were broadly stable. Recall that in the federal election both those states recorded sizable swings against the sitting Labor government, presumably partly because of the mining tax.
Given that the survey was conducted after the Labor government successfully formed a minority government there appears to have been a high degree of disappointment in those states with the final resolution of the election. This element of political disappointment may fade in time but is likely to affect households' decisions in the near term.
However, we do not believe that the political issue has been the only one affecting our assessment that consumers remain cautious. As discussed, we believe that the "wisest saving" preferences are also very important for assessing likely household behaviour and whether consumers are becoming less cautious. In that regard we notice that the largest increases in preference to pay down debt came in South Australia (up 8.5 per cent); NSW (up 7.6 per cent) and Queensland (up 5.4 per cent) whereas WA (up 1.8 per cent) and Victoria (up 0.3 per cent) were much more modest.
The Westpac-ACCI Survey of Industrial Trends which was released on September 16 showed a similarly surprising fall in its Actual Composite Index; its Expected Composite Index and the Labour Market Composite Index. Around 80 per cent of the responses were recorded in the two weeks following election day.
The survey showed a fall of 7.1 points in the Actual Composite Index (or 12.5 per cent). That index is a weighted average of employment; new orders; output; delivery times; and overtime. It would partly reflect political uncertainty of the firms (employment and overtime) and partly the uncertainty of the firms' customers (new orders; output; delivery times).
We use the Actual Composite as a useful lead indicator for business investment. The Composite still remains well in the zone consistent with stronger accelerating annual growth in plant and equipment investment but the outlook is less buoyant than previously expected. That was also supported by a substantial easing in capacity utilisation, losing half the gains over the last five quarters. Investment plans for both plant and equipment and buildings also fell sharply to below decade average levels.
The Expected Composite fell by 4.6 points (or 8.4 per cent) from Expectations in June. The Expected Composite for the December quarter is now around the same level as the Actual Composite for the September quarter. Firms may be expecting that the element of political uncertainty which may have affected their sales in September may be lingering in the December quarter.
The highly reliable Labour Market Composite also fell in September. It was down by 7 points to zero – now below the decade average level of 4 points. We use the index as one input to our employment growth forecasts. The current level of the index is indicating a slowdown in employment growth from the 3 per cent annual pace we expect for the second half of 2010 to 2 per cent in the first half of 2011. That growth pace would be broadly consistent with a stable unemployment rate rather than the modest reduction which we currently expect through 2011.
The disappointing results from both our Consumer and Business survey have undoubtedly been partly impacted by political uncertainty and disappointment, although we have no doubt other forces have been at work.
The Business Survey results indicate that as a result of this uncertainty activity has already been affected and can be expected to continue to be affected in the near term. With the passage of time we should expect these influences to pass. But the surveys do point to both business and consumers being more tentative than we had expected.
These results do reinforce our case for the RBA to delay any rate hikes until 2011 when, in particular, we will have a more reliable read on both the consumer and firms.
Bill Evans is Westpac chief economist.
WEEKEND ECONOMIST: Labor's crisis of confidence
Labor's win appears to have hit consumer confidence in Queensland and WA. With jitters in the mining states, the Reserve Bank is unlikely to move until next year, disappointing those tipping a December hike.
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