Consumer Sentiment Indicators and the Economic Outlook

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1 Consumer Sentiment Indicators and the Economic Outlook July 2014 Key Points: Consumer confidence fell sharply after federal Budget 2014/15 and there are concerns about the budgets implications for economic activity. In the past, consumer spending has been sensitive to changes in consumer confidence. However, the link between new dwelling construction and consumer sentiment has been less pronounced. Consumer sentiment is being influenced by the government s budgetary situation and some weaknesses in the economy. However, there are several positive indicators including low interest rates, low inflation, strong home price growth and robust stock prices. It is likely that strong home price growth and record-low interest rates will continue to support high levels of new home building, irrespective of movements in sentiment. What does consumer confidence tell us about the economic outlook? Fluctuations in consumer confidence indicators are not always replicated by actual consumer activity. This paper shows how changes in consumer sentiment should be seen as a very general guide to how consumers might behave, rather than a reliable forecast of what is definitely coming down the tracks. The Westpac-Melbourne Institute s Consumer Sentiment index has performed well in predicting quarterly changes in the household consumption component of GDP over the past two decades. This means that the sharp drop in consumer sentiment post- Budget 2014/15 is likely to be reflected in weaker retail spending activity. Confidence had been slipping since the second half of last year as sections of the economy weakened and the federal Budget failed to find traction. This means that weaker household consumption growth over the near term is likely. There are a number of specific changes that could revive consumer sentiment such as an orderly depreciation of the Australian dollar, a rebound in commodities prices and a quicker improvement in the international economy. Housing Industry Association Ltd 79 Constitution Ave Campbell ACT 2612 p f hia.com.au HIA s research also shows how the Time to Buy a Dwelling Index s predictive performance with respect to new dwelling commencements is much less reliable. Accordingly, the strong appetite for home purchase which is supported by strong dwelling price growth and low interest rates, is likely to remain robust, at least in the short term.

2 HIA Economics Research Note July 2014 Consumer Sentiment Indicators and the Economic Outlook Introduction Since the announcement of the federal Budget in May, there has been considerable focus on the subsequent decline in consumer confidence. This paper looks at how consumer spending and new home building have reacted to changes in consumer sentiment in the past. Recent developments in consumer confidence The Westpac-Melbourne Institute Consumer Sentiment Index is the most widely quoted barometer of consumer sentiment in Australia 1 and its monthly results over the past two decades are illustrated below. A score of greater than means that optimists outnumber pessimists, with readings of below indicating that pessimistic consumers are in the majority. The ANZ/Roy Morgan Consumer Confidence Index is another long running barometer of household sentiment in Australia, currently issued on a weekly basis. The highest monthly reading for the Westpac-MI Consumer Sentiment Index recorded over the review period was in May This was immediately after the 2007/08 Budget, which included tax cuts and spending increases. At this time, the ASX stock market index was at an all-time high and strong employment growth brought unemployment to a three decade low. The fact that the Australian dollar was strong on foreign exchange markets is also credited with boosting consumer sentiment at this time. Consumer Sentiment Index Source: Westpac-Melbourne Institute Jun-94 Jun-96 Jun-98 Jun-00 Jun-02 Jun-04 Jun-06 Jun-08 Jun-10 Jun-12 Jun-14 Remarkably, the consumer sentiment index fell to a fifteen-year low within about a year of reaching its all-time high. The rapid onset of the GFC during 2008 saw the index fall to 79.0 by July This remains the lowest monthly result recorded over the past two decades. Consumer confidence faltered substantially during the first half of Since hitting a high of in November 2013, consumer sentiment fell to 92.9 in May before recovering slightly to 94.9 in July. The index remains well below the crucial threshold and has fallen by 14 per cent since November last year. The figure below summarises the current state of play with respect to the key determinants of consumer sentiment. 1 The Melbourne Institute of Applied Economic & Social Research Page 2

3 HIA Economics Research Note July 2014 Consumer Sentiment Indicators and the Economic Outlook Key Determinants of Consumer Sentiment as at July 2014 Factor Government Finances Comments The 2014/15 Budget was the toughest in years and there is no prospect of budgetary surplus in the near term. There is a real risk of further expenditure reductions and/or tax increases. Economic Growth The slowdown in mining has caused growth to fall below trend but other sectors are starting to fill the gap. The unrelenting strength of the Australian dollar on international currency markets is holding back the traded sectors of the economy. Inflation Inflation is stable and within target. Interest Rates Interest rates have remained at an all-time low rate over the past year and are set to remain unchanged for some time. Even in the unlikely event of a change to rates, the market currently views a further reduction as being more likely than any increase. Labour Market At 6 per cent in June, unemployment is at its highest in a decade, although the pace of employment growth has speeded up since the start of International Economy Advanced economies continue to recover slowly, while there are some concerns about a deceleration of growth in China. The Euro area crisis looks to have passed. Stock Market The ASX is at its highest point since mid-2008 and has risen about 15 per cent over the past year alone. Commodities prices Key commodities prices like coal and iron ore have fallen over the past year, putting related resource activities under pressure. Dwelling Prices Home prices have increased in all capital cities over the past year, particularly strongly in Sydney and Melbourne, as well as from a low base in Brisbane. Mixed Favourable Unfavourable Examination of the above chart illustrated that consumers worries about the budgetary position and the implications around falling commodities prices are likely to be superseding other considerations at this time. The state of the labour market, the pace of economic growth and international risks are also the source of some unease. High profile events like the closure of GM Holden and Toyota manufacturing operations in Australia and difficulties at Qantas have added to the perception of economic weakness. Despite these negatives, a number of positives continue to benefit households. These include the emergence of significant dwelling price growth over the past eighteen months and the fact that interest rates are set to remain at record lows for some months yet. Over the past year, the international economic environment has enjoyed its most stable period since the outbreak of the GFC. Accordingly, it is likely that consumer sentiment would be even lower in the absence of these elements. The purchase of a home represents the largest single lifetime transaction for many households. As a result, sentiment may influence the timing of their participation in the home purchase market. As the threat of job loss, reduced working hours, tax increases or any other reductions in income gets bigger, consumers will be less likely to take on the additional long-term debt usually required for home purchase. On the other hand, stronger dwelling price growth tends to prompt potential home buyers to enter the market earlier in order to Page 3

4 Dec-1993 Dec-1995 Dec-1997 Dec-1999 Dec-2001 Dec-2003 Dec-2005 Dec-2007 Dec-2009 Dec-2011 Dec-2013 Percentage of disposable income HIA Economics Research Note July 2014 Consumer Sentiment Indicators and the Economic Outlook avoid paying a higher purchase price at a later stage. Significant rental inflation has the same effect, as home purchase becomes more affordable relative to renting one s home. Interest rates also matter in respect of dwelling purchase, both in terms of their level and expectations around them. Lower interest rates make borrowing costs cheaper and tend to encourage greater purchase activity. However, this effect will be blunted should expectations grow that interest rate increases are in prospect. Does sentiment actually influence real economic activity? One of the main purposes of measuring consumer sentiment is to get a lead on the likely development of economic activity. Retail sales and home market activity are regarded as being particularly sensitive to household confidence. Interestingly, the RBA has recently played down their usefulness in this regard, noting that while low-frequency movements in [consumer] confidence measures had been broadly associated with trends in consumption spending, there was little evidence from the historical record that high-frequency movements carried much predictive content. 2 Since consumer sentiment tumbled at the start of the GFC in 2008, perhaps the most profound effect has been on the household savings rate. This is shown in the chart below. Household Savings Rate, 1993 to 2013 Source: HIA Economics, ABS 14% 12% 10% 8% 6% 4% 2% 0% -2% The savings rate began rising from 3.7 per cent in 2007 as the RBA s rate tightening cycle quickened. However, savings surged during the onset of the GFC and have remained above 10 per cent ever since. This is an example of the inconsistent nature of consumer sentiment s effect on behaviour. As would be expected, savings did increase at a time when sentiment plunged. However, the opposite did not hold true when confidence saw a recovery in , with savings remaining high. This situation is all the more notable given that large interest rate reductions took place at this time. It is also useful to compare consumer sentiment with household consumption, something illustrated by the chart below. It can be seen that there is quite a close relationship between the two variables. This suggests that consumer sentiment has an effect on consumer behaviour in terms of their spending. This means that weaker consumer sentiment propagates lower economic growth through the effect of reduced household demand. Similarly, demand in the economy will tend to benefit from stronger consumer confidence. Given the sharp fall in consumer sentiment post-budget, it is likely that household consumption growth will soften over the short term at least. 2 Reserve Bank of Australia (2014) Minutes of the Monetary Policy Meeting of the Reserve Board [June] Page 4

5 Jun.1994 Jun.1998 Jun.2002 Jun.2006 Jun.2010 Jun.2014 Consumer Sentiment Index Household Consumption Growth (Quarterly) HIA Economics Research Note July 2014 Consumer Sentiment Indicators and the Economic Outlook Comparison of Household Consumption Growth and Consumer Sentiment, 1993 to 2013 Source: Westpac-Melbourne Institute; ABS 130 5% 4% 110 3% % 1% 0% -1% 50-2% Mar-94 Mar-96 Mar-98 Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Consumer Sentiment Index [LHS] Household Consumption Growth [RHS] In addition to the overarching Consumer Sentiment Index, Westpac and the Melbourne Institute gauge consumers attitudes towards home purchase through the Time to Buy a Dwelling (TBD) Index. A score of more than indicates that a majority of respondents regard it as a favourable time to purchase while less than indicates that the majority view it as an unfavourable time to buy. This index has been compiled since March 1995, originally on a quarterly basis. Since January 2007, it has been produced on a monthly basis. The quarterly results since June 1994 are illustrated in the chart below. Time to Buy a Dwelling Index, 1995 to 2014 Westpac - Melbourne Institute Time to Buy a Dwelling Index 'Good' time to buy > 'Bad' time to buy < 40 An acceleration of home price growth and the decision by the RBA to reduce interest rates to record lows brought the Time to Buy a Dwelling Index up to in September 2013, one of the highest readings over the past decade. The index has since fallen back by some 23 per cent, although a sizeable majority of respondents still regard it as being a favourable time to purchase a dwelling. The decline since September is likely explained by the weakening of the labour market and some key segments of the economy, as well as the unfavourable reaction of consumers to Budget 2014/15, and some worries about China s economy. Page 5

6 Change in Commencemnets (Quarterly) Time to Buy a Dwelling Index HIA Economics Research Note July 2014 Consumer Sentiment Indicators and the Economic Outlook The chart below provides an overview of the Time to Buy a Dwelling Index and quarterly dwelling commencements. One would expect that improved sentiment towards home purchase would be followed by increased market activity some time later. The chart below confirms this pattern to some degree with the two series moving in tandem in a very broad sense. Compared with household consumption, the variation in dwelling commencement activity from quarter to quarter is much more pronounced. In some instances, the TBD Index has been of some predictive value with a lead time of one to two quarters. On other occasions, however, significant variations in the TBD index have not been matched by subsequent changes in dwelling commencements. Similarly, some substantial changes in dwelling commencements have occurred which were not matched by earlier movements in the TBD Index. Comparison of New Dwelling Commencement Growth and Time to Buy a Dwelling Index, 1993 to 2013 Source: Westpac-Melbourne Institute 30% 20% 10% % -10% -20% -30% % 0 Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13 Change in Dwelling Commencements (LHS) The Highs and Lows of Consumer Sentiment Time to Buy Dwelling Index (RHS) It can be seen that consumer sentiment is subject to considerable fluctuation, with monthly changes averaging 2.5 per cent in magnitude over the past year. This compares with an average monthly change of 3.9 per cent over the past two decades. On four occasions, increases of greater than 7 per cent have occurred. These are summarised in the table below. Largest Monthly Increases in Consumer Sentiment Index, 2009 to 2014 Month Percentage Change Reasons Jun % Solid stock market rebound, commencement of government stimulus and healthier than expected economic figures Jul % Easing of global financial tensions and more clarity around the mining tax Sep % Reduced prospects of RBA interest rate increase and stronger than expected economic data Feb % Strong stock market performance, steadying international conditions and increasing prospects of RBA interest rate cut Page 6

7 HIA Economics Research Note July 2014 Consumer Sentiment Indicators and the Economic Outlook The analysis of these increases offers a good insight into the key factors that affect consumers most. The government s budgetary policy is crucial, with increased expenditure and more certainty around taxation policy tending to strengthen household confidence. Asset prices, particularly stock markets also matter to consumers and Australia s linkage to the global economy means that households are sensitive to international conditions. Expectations about changes to interest rates have also been shown to have an important effect on consumer sentiment. The importance of the government finances in shaping consumer sentiment is evidenced from the table below, which summarises the sharpest falls in consumer sentiment in the years since 2008, all of at least 6 per cent in magnitude. Interestingly, sentiment has recorded substantial falls in the immediate aftermath of three of the past five federal Budgets. This further emphasises the inextricable link between the health of the nation s finances and consumers perceptions of economic well-being. International developments have also adversely affected consumers in recent years, with the financial markets chaos in late 2008 and the Euro area crisis in 2010/11 playing particularly badly. Weak dwelling prices, stock market falls and the likelihood of interest rate rises have all served to wound consumer confidence at various times over the past few years. Biggest Monthly Falls in Consumer Sentiment Index, 2008 to 2014 Month Percentage Change Reasons Oct % Dec % Severe deterioration in international financial markets resulting from Lehman Brothers collapse in the previous month Prolonged period of bad international economic news, fears of Euro currency collapse, falling stock markets, weak dwelling prices, increased unemployment and worries about federal government finances May % Continued RBA interest rate hikes and eruption of sovereign debt crisis in Greece May % Negative response to Budget 2013/14 and worries about deteriorating government finances May % Announcment of 2014/15 federal Budget which focused on achieving balance through expenditure reducing measures When it comes to consumer sentiment, large movements are rarely matched fully by relevant indicators of aggregate activity. The pattern of past behaviour suggests that the deterioration of consumer confidence since late last year will have some mildly adverse effect on retail spending growth. However, there will not necessarily be any negative implications for new home building activity. In the short term at least, new home building is likely to remain quite high due to the combination of strong dwelling price growth and the backdrop of very low interest rates. The deterioration of consumer sentiment since last year has been led by weaknesses in the labour market, and slower growth in key economic sectors, particularly mining investment. There remain some positives in the economic mix, including strong dwelling price growth, low interest rates, fairly stable inflation and the stock market performance. These cheer factors may yet form the basis for some recovery of consumer sentiment as we proceed through the second half of Page 7