WEEKEND ECONOMIST: Problematic participation

The Westpac-Melbourne Institute Index of Consumer Sentiment increased by 1 per cent in October from 98.2 in September to 99.2 in October.

That was another disappointing result. There were a number of reasons to have expected the Sentiment Index to have increased by more than only 1 per cent.

Firstly, and most importantly, the Reserve Bank cut its overnight cash rate by 0.25 per cent from 3.50 per cent to 3.25 per cent. Unlike some moves by the RBA which are fully expected by the media and therefore may not have a marked impact on confidence this move was not widely expected and therefore should have registered as a ‘pleasant surprise' for respondents.

Instead we saw the sentiment of those folks with a mortgage hardly move with a minuscule 0.6 per cent increase. Of course a likely complication was the response of the major banks, most of which only announced their mortgage rate reductions on October 5 – five days into the seven day sample period – with reductions ranging from 0.18 per cent to 0.20 per cent.



Since the RBA embarked on this recent easing cycle in November last year the cash rate has been cut from 4.75 per cent to 3.25 per cent while the standard variable mortgage rate has been reduced from 7.80 per cent to around 6.65 per cent. Of more interest is that since december the bank has cut the cash rate by 100 basis points while the standard variable mortgage rate has been reduced by 65 basis points. It is of some concern that the Consumer Sentiment Index is still significantly below its level of last November following the first 25 basis point cut in the overnight cash rate. Since that time the RBA has cut the overnight cash rate by a further 125 basis points but the index is now 4.1 per cent lower.

Secondly, we saw a surprise fall in the unemployment rate from 5.2 per cent to 5.1 per cent reported for August. In that regard, however, we have seen consistent evidence from consumers' unemployment expectations that despite a low print on the unemployment rate the vast majority of consumers have been expecting and continue to expect unemployment to rise.

That expectation was franked with the September employment report which was released two days after the release of the October Consumer Sentiment Report. The unemployment rate was reported to have risen from 5.15 per cent to 5.44 per cent. That was despite an increase in the number of jobs of 14,500. Because the participation rate rebounded in September to 65.2 per cent, fully reversing the August dip to 65.0 per cent, the workforce increased by 53,300 yet the economy was only able to add 14,500 jobs, a clear sign of a weak labour market.

As we have stressed in the past, when the participation rate is moving the key measure of the Employment Report is the unemployment rate rather than the number of jobs gained or lost. Think of the marginal performance. With the unemployment rate around 5 per cent an increase in the workforce of 53,300 should be associated with jobs gain of around 50,000 – not 14,500. Markets' penchant for focusing on the headline jobs number is only appropriate when there are no unusual movements in the labour force, usually due to an unstable participation rate.

While the participation rate rose in September the general trend has been lower as workers withdraw from the labour force in light of reduced employment opportunities. Over the last year the participation rate has fallen from 65.6 per cent to 65.2 per cent. Had it not fallen then the unemployment rate would be around 6.0 per cent. This effect is best captured with the employment to population ratio which is now at its lowest level since late 2009, when the unemployment rate was around 5.75 per cent.




As the RBA is now acknowledging the labour market has weakened and the September Employment Report is supporting evidence of that view. In last week's note I signalled that such a result was a genuine possibility: "If, for example, the participation rate corrected back to 65.2 per cent in September the workforce would increase by 46,000. A modest jobs increase of around 15,000 would see the unemployment rate jump to 5.4 per cent."

Evidence of the weakness in the labour market continues to be presented by the Westpac-Melbourne Institute Index of Employment Expectations. In October the index did "improve" by 1.7 per cent but is still nearly 25 per cent weaker than the average in 2011 and 9 per cent "worse" than before the RBA started the latest easing cycle.

Another factor that should have buoyed consumer confidence in October was news from overseas. The announcements of unlimited quantitative easing by the US Federal Reserve and the provision of an unlimited bond buying facility by the European Central Bank were very positive developments.

Since the announcement of those bold stimulus programs we have seen a surprisingly downbeat assessment from the IMF in their six-monthly report: "Downside risks are now judged to be more elevated than in April 2012 and September 2011." This assessment will not go unnoticed at the Reserve Bank. Recall that the key reason for the October rate cut: "On the back of international developments the growth outlook appeared a little weaker."

The October print of the Consumer Sentiment Index represents the eighth consecutive month below 100, indicating that pessimists outnumber optimists. It is the 14th month in the last 16 that the index has been below 100. That compares with the February 2008-May 2009 period when the index was below 100 for 16 consecutive months. That last period of sustained weakness was followed by a strong and sustained surge with the index posting consecutive increases of 12.7 per cent, 9.3 per cent, 3.7 per cent, 5.2 per cent, and 1.8 per cent in the five months from May 2009. The surge of 2009 followed: official evidence that Australia had avoided a recession; a huge fiscal stimulus (around 5 per cent of GDP); a cumulative reduction in the overnight cash rate of 425 basis points over the previous six months; and a large, globally coordinated round of stimulus packages from the major economies (most notably China).


In contrast, the situation now has: fiscal policy firmly in the contractionary zone; growth surprises looking more likely to be to the downside; the overnight cash rate only having fallen by 150 basis points;and, apart from China, the major economies unable to undertake further stimulus. As such, a 2009–style recovery looks decidedly unlikely this time around.

Despite the subdued headline there were some slightly more promising signs in the October Consumer Sentiment survey detail.

Three of the five components of the index increased and two were down.

Encouragingly both components around family finances increased: the sub-index tracking views on ‘family finances compared to a year ago' was up 5.3 per cent and expectations for‘family finances over the next 12 months' was up 2.8 per cent. We had been very concerned about the weakness in the ‘finances outlook' series back in June when it was at levels comparable with the depths of the global financial crisis. It has since increased by a healthy 14.6 per cent. This improvement may be partly due to less intense concerns around the introduction of a price on carbon emissions, although the overall performance of the component remains disappointing (up just 1.6 per cent Since november last year). In a promising sign for retailers, the subindextracking views on ‘whether now is a good time to buy a major household item' also increased by 3.7 per cent. Weakness in October centred on views around the economy.

The sub-index on ‘economic conditions over the next 12 months' fell by 2.4 per cent; while the sub-index on the five year economic outlook was down by 4.6 per cent.

The most encouraging result from the survey came from the index tracking views on ‘time to buy a dwelling' which surged 9.6 per cent to be up 17.9 per cent in two months and reaching its highest level since September 2009 at 139.8. During that 2008/2009 period this index was the first of the survey indexes to recover from the ravages of the GFC. It began its surge from December 2008 when it reached 136.8 and held steadily in that 135-145 range until the Reserve Bank first raised the overnight cash rate in October 2009. Over the 12 months from December 2008 to December 2009 house prices increased by around 13 per cent to be followed by a 5 per cent increase over the subsequent 12 months. That 13 per cent increase in house prices through 2009 was despite overall consumer sentiment and employment expectations remaining very weak in the first half of 2009 prior to, as discussed, the surge in Confidence in the second half of 2009.

This positive signal around housing from the index will warrant further perusal. The message is consistent with other recent evidence of firming auction clearance rates and stability in house prices.

The RBA board next meets on November 6. We expect that the board will decide to cut the overnight cash rate by a further 0.25 per cent. Our forecast for this cut has been in place since May this year with our forecasts around global uncertainty; softening domestic growth; a weak labour market and dormant inflation all setting the scene for another move by the bank.

In May we also pointed out that the overnight cash rate was unlikely to bottom out by year's end with a further cut to 2.75 per cent likely early in the new year.

Historic precedent around this November move is mixed. The bank has adjusted the cash rate every November since the current governor assumed the role in 2006. On the other hand, last time when the cash rate got to 3.25 per cent in February 2009 there was widespread expectation that the bank would move again in March. In the event it surprised all by not moving, only to move again in April.

Bill Evans is Westpac's chief economist.