WEEKEND ECONOMIST: Not yet neutral

This month's upswing in consumer confidence points to the potency of monetary stimulus, and with a weak labour market and inflation pressures, another rate cut is not far off.

The Westpac Melbourne Institute index of consumer sentiment rose by 3.5 per cent in August, from 102.1 in July, to 105.7. This was the highest print for the index since March 2013. In that February-March period, the index surged by nearly 10 per cent, and we were encouraged that consumer confidence was finally on a sustained upswing. However, the index subsequently lost momentum. If we exclude February-March, this month's print is the highest since February 2011.

It is way too early to proclaim this result as a potential turning point, as some were expecting in February-March. That turning point will only be reached when we see a much more positive environment for business investment and employment intentions. In fact, the index is still 7 per cent below the average read in 2010, when households had become quite optimistic that the potential fallout from the global financial crisis had passed. Despite the Reserve Bank cutting rates by 2.25 per cent so far in this cycle, the index is only 2.3 per cent above the level achieved following the first rate cut of 0.25 per cent in November 2011.

A number of important forces were operating over the month, which had an impact on consumer sentiment. Most important was the decision by the Reserve Bank to cut its overnight cash rate by 0.25 per cent and the passing of this cut in full through to mortgage rates. (Westpac passed on 28 basis points.) There was also the announcement of the September 7 election date; the government’s economic statement, which revealed a further deterioration in the fiscal position; and the consolidation of the Australian dollar around 15 per cent below its recent peak in April.

The interest rate decision was announced on the second day of the seven-day survey period. In those first two days, the index averaged 102.4 (up just 0.3 per cent from the July reading). For the final five days of the survey, the index averaged 107.4 (up 5.2 per cent from the July reading). This indicates that the rate cut is likely to have had a solid positive impact on consumer sentiment. It also indicates that a negative response to the government’s economic statement (released on August 2, three days before the beginning of the survey period) which featured a further $33 billion deterioration in the fiscal position was not apparent. Equally, there does not appear to have been much impact on consumer sentiment from the announcement of the election date one day before the survey period.

Of course, it is possible that those two forces offset one other, but we have no way of testing that hypothesis. That contrasts to the response in May when the index fell 7 per cent despite a rate cut. On that occasion, the sharp deterioration in the fiscal position ($80 billion from the previous budget estimate) seemed to overwhelm the positive impact of the Reserve Bank’s rate cut, announced on May 7.

The timing of the two events was reversed in August relative to May, with the interest rate decision coming almost two weeks before the survey period. It is also possible that the Budget deterioration in May emphasised to households that the reason behind the rate cut was a weak economy. Further evidence of the positive response to the rate cut can be found in the response of those folks with a mortgage: their confidence rose by 7.4 per cent in August. It also appears that the consolidation of the Australian dollar at a lower level may have also played a positive role for consumer sentiment.

Despite the rate cut, confidence in metropolitan areas improved by only 1 per cent over the full week, whereas confidence in non-metropolitan areas rose by 11 per cent. This latter response would have been a combination of relief for borrowers and a confidence boost for rural communities, thanks to the improved export outlook associated with the more competitive Australian dollar. While the response in the metropolitan areas was quite muted over the whole week, there was still a marked increase in confidence in the metropolitan areas following the rate cut decision. The metropolitan index was up nearly 5 per cent in the second five days relative to the first two days of the survey period.

Metropolitan respondents were also less sanguine about the economic statement. Confidence among metropolitan households fell by 2.1 per cent for the “pre rate cut” sample. There was also a bounce in the outlook for housing with “time to buy a dwelling” increasing by 3.7 per cent. That result was slightly disappointing, given that “time to buy a dwelling” had fallen by 8.4 per cent last month and that the index had risen by 11.2 per cent following the May rate cut.

We do not think this result is a turning point in the series, as respondents remain deeply concerned about job security. Despite the 3.5 per cent jump in the overall sentiment index, the index for “unemployment expectations” was unchanged. Households may have felt better around their finances in light of the rate cut, but they have not become more comfortable with their job prospects.

We noted that the index was still 7 per cent below its average level for 2010. Compare that with the “unemployment expectations” index, which is 43 per cent above its average 2010 print (a higher print indicates more concern around employment security and prospects). Further, this index is 17.3 per cent above its November 2011 print, following the Reserve Bank’s first rate cut. This compares with a modest improvement in households’ assessment of their overall confidence. The contrast between metropolitan and non-metropolitan respondents is also apparent in the “unemployment expectations” index, with the metropolitan index increasing by 2 per cent compared to the non-metropolitan index’s 4.1 per cent decline. 

The Reserve Bank board next meets on September 3. Following the decision to cut rates on August 6, the governor indicated in his statement that the board had moved from the easing bias it had adopted for recent meetings to a more neutral stance. With rates at record lows, the 15 per cent fall in the Australian dollar since April, it seems reasonable that the board should take a step back to assess developments. We are not expecting a move in September, but we have retained our view that there will be another cut at the board’s meeting on November 5. As the Australian dollar stabilises, the labour market continues to weaken, inflation pressures remain contained, and business confidence and investment remain soft, the case for further stimulus will be strong. 

Bill Evans is Westpac's chief economist.