WEEKEND ECONOMIST: On course for a November snip

Consumer sentiment is weak, risk aversion among savers is high, fiscal policy is tightening and, bar mining investment and unemployment dips, the case for interest rate cuts is still strong.

The Westpac-Melbourne Institute Index of Consumer Sentiment rose by 1.6 per cent in September from 96.6 in August to 98.2 in September.

This is the seventh consecutive month that the index has been below 100. Apart from the 2008-09 period when the index held below 100 for 16 consecutive months this represents the longest run of consecutive ‘sub 100’ prints since the early 1990s.

Furthermore, there have only been two months in the last 15 when the index has printed above 100.

The consumer is clearly stuck in an extended ‘cautiously pessimistic’ phase. In September last year the index printed 96.9 so it has only increased by 1.3 per cent over the whole year. That is despite 125 basis points of rate cuts from the Reserve Bank; a more or less steady unemployment rate which is close to full employment; and some recent positive news around the threatening European situation.

This does not bode well for consumer spending and is consistent with the slowdown in consumer spending indicated by the June quarter national accounts. Although this followed a strong March quarter rise, the softening has come despite major policy boosts to household incomes including $1.9 billion in fiscal handouts.

With a sharp fall in July retail sales confirming this boost is now reversing, underlying momentum appears to be soft, in line with the consistently downbeat signal from the Consumer Sentiment Index.

Media coverage is often a major factor shaping respondents' confidence including how they assess their own financial position and how they evaluate macro issues.

In the September report we receive an update on the news items which are capturing the attention of consumers and whether these were favourable or unfavourable. It shows the dominant news in September was around ‘economic conditions’ with 47 per cent recalling news on this issue. Next was ‘budget and taxation’ (39.8 per cent recall); international conditions (25.5 per cent recall); and employment/wages (20.6 per cent recall). Other topics registering lower recall include covered interest rates; inflation; politics and the Australian dollar.

Since June, the overall sentiment index has increased by a modest 2.7 per cent. Respondents generally recalled slightly less unfavourable news on international conditions although these items were still overwhelmingly negative. Other news was viewed as even more unfavourable than in June.

Four of the five components of the index increased with the subindexes tracking views on "family finances compared to a year ago" up 0.3 per cent; "family finances over the next 12 months" up 4.8 per cent; "economic conditions over the next 12 months" up 0.6 per cent and "economic conditions over the next five years" up 3.4 per cent. The subindex tracking views on "whether it is a good time to buy a major household item" fell by 0.4 per cent.

By June this year we were particularly concerned by readings on "family finances over the next 12 months" which was printing at a level around the low-point of the 2008/09 period. Since then we have seen an encouraging improvement in this component which has increased by 11.4 per cent. However, it is still at a historically low level. For example the average print of that component during that 2008/09 period when the index registered 16 consecutive months below 100 was 105.2 – the print of 96.2 is still well below that average. We can only conclude that respondents remain concerned about their finances despite the recent rally.

This survey also provides a quarterly update on respondents' savings preferences. There was a sharp increase in the proportion of those respondents who assess bank deposits to be the wisest place for savings, with that proportion increasing from 32.6 per cent in June to 39.0 per cent in September. That proportion is the highest proportion since December 1974 and comfortably exceeds the peak proportion during the 2008/09 period of 36.9 per cent. For this survey the 6.4 percentage points increase in preference for bank deposits was at the expense of real estate which fell from 25.0 per cent in June to 19.8 per cent in September. The proportion of respondents favouring shares stayed near record lows at 5.5 per cent, while the proportion opting for ‘pay down debt’ was steady at 20.4 per cent.

If we compare the total proportion of respondents who prefer conservative savings options, covered by bank and other forms of deposits in conjunction with "pay down debt" the current proportion registers 63.5 per cent of respondents. That compares with 64.2 per cent in December 2008 when we were at the height of risk aversion during the global financial crisis. In short, respondents are exhibiting a similar level of risk aversion in terms of their savings preferences as we saw in 2008.

The Westpac-Melbourne Institute Unemployment Expectations Index rose 1.0 per cent in September after rising 3.8 per cent in August. The index is up 5.9 per cent over the past year and 56 per cent since the February 2011 trough.

Since the early 1990s there was only one other time when the index rose so rapidly – during the GFC episode when the index rose 82 per cent between May 2007 and February 2009. Households' growing concerns are not consistent with the so called "full employment" measure from the ABS. It suggests that the domestic labour market is softening and that the unemployment rate, which has been relatively stable of late near 5 per cent, is likely to move higher during the second half of 2012.

Had the participation rate not declined over the past year, the unemployment rate would have already risen to 6.0 per cent. That decline is reflecting a discouraged worker effect as male full time workers are losing their jobs in construction; manufacturing; finance and government and not accepting or seeking jobs in the growth areas of health services; mining; and professional services. Over the past year, the working age population has risen by 238,000 but only 62,000 jobs have been created; that has resulted in the employment to population ratio falling 0.5 percentage pointss to a near three-year low.

The Melbourne Institute Survey of Consumer Inflation Expectations was unchanged at 2.4 per cent-year in September after falling by 0.9 percentage points in August. The median expected inflation rate of Managers & Professionals fell by a full percentage point to 2.2 per cent in September.

The September outcome suggests that inflation expectations have stabilised within the RBA's target band after July's spike to 3.3 per cent year, which arguably was the result of concerns over the inflationary impact of the carbon tax.

Every six months we also survey wage expectations. Between March and September we have seen a notable easing in wage expectations. The proportion of respondents expecting wages to stay the same or fall increased from 42.5 per cent to 47.1 per cent. In contrast, the proportion of wage earners expecting wages to rise between 1 and 4 per cent fell from 39 per cent to 33.3 per cent and 4 to 8 per cent from 11.2 per cent to 9.2 per cent.

Despite an expansion of the ranks of the super optimists (increase in proportion expecting wages to increase more than 8 per cent rose from 7.4 per cent to 10.4 per cent) the clear message is that wage expectations are more subdued than six months ago.

Western Australia was a notable weak spot in the September Consumer Sentiment survey. Whereas the national index was up 1.6 per cent in the month, sentiment out west dropped 5.4 per cent, the biggest decline of the major states. The detail showed a particularly sharp 8.9 per cent drop in expectations for the economy over the next 5 years that stands in stark contrast to a 3.4 per cent rise nationally.

Labour market expectations also registered a bigger shift in the west with consumers' unemployment expectations deteriorating 3.3 per cent versus 1 per cent nationally and an additional question on wage growth expectations showing a much sharper drop versus March compared to the rest of the nation. In all of these cases, consumer views are coming from a much more positive starting point than the rest of the nation.

And the hit to WA consumer confidence in September falls well short of a 'collapse' – indeed WA consumers were more rattled midway through last year and in late 2011 – but given how dependent and 'tuned in' the state is to the mining boom this may be an early signal of an ongoing shift.

The Reserve Bank Board next meets on October 2. Our forecast has been and remains that the bank will decide to cut the official cash rate by 50 basis points over two meetings by year's end. The case for lower rates is strong. Inflation remains well contained and the bank's own forecast has inflation remaining consistent with the target over the next one to two years. Interest rates are only slightly below neutral levels. The June quarter national accounts showed that consumer spending is slowing and investment in residential construction and plant and equipment has been contracting for the last few quarters.

Despite a near 10 per cent fall in the terms of trade the Australian dollar has failed to perform its usual ‘shock absorber’ role. Fiscal policy at both federal and state levels is tightening. Both consumer and business confidence are soft. From a domestic perspective only the fall in the unemployment rate and the ongoing surge in mining investment counter the case for lower rates. However, the fall in the unemployment rate has been due to discouraged workers leaving the workforce while the medium term outlook for the mining investment has recently been revised down by some mining companies.

In short, we think the case for lower rates has already been made and there must be a reasonable chance that the bank will decide to move in October. However, central banks are conservative so a November ‘call’ for the first move looks to be more prudent.

Bill Evans is Westpac's chief economist.


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