The Westpac–Melbourne Institute Index of Consumer Sentiment fell by 3.2 per cent in July to 92.2, down from 95.3 in June.
This was the lowest print of the index since December last year. It is now firmly in the range where pessimists outnumber optimists. In fact, the index has printed below 100 in 15 of the last 17 months.
It is not surprising that we saw a solid fall in July. We had a taste for households’ sensitivity to disturbing news around European instability in December 2011 when the index tumbled by 8.4 per cent from 103.4 to 94.7.
This time the concerns around Greece have been complemented by sensational coverage of the collapse in the Chinese sharemarket.
Back in 2011, the index recovered by 6.7 per cent once European fears settled down and it is likely that the impact on confidence of the European developments will once again prove to be transitory. However, such volatility will not disguise the fact that underlying consumer confidence in Australia remains consistently low.
Markets also appear to be of the view that the current Greek controversies are political rather than foreboding any significant short-term risks for the European economy. Through 2011 the spread between periphery bonds (Italy and Spain) and German bunds blew out by 600 and 375 basis points, respectively, whereas in the current ‘crisis’ spreads have increased by 25 and 40 basis points, respectively.
These spreads will have been partly impacted by the ECB’s QE program but much more importantly by the minimal fears around any contagion from Greece to other European countries in the event of a Grexit. With the IMF calculating that the only sensible chance for a Greek recovery is a total restructure / moratorium on debt for 30 years, the current arrangements which are being negotiated are only likely to delay another crisis in the near future.
Further evidence that this headline impact from overseas news is unlikely to be sustained can be found in the response of households to the outlook for the unemployment rate. As readers will be aware we have been concerned for some time around the persistently elevated concerns that respondents have for the outlook for the jobs market.
The Westpac Melbourne Institute Index of Unemployment Expectations actually fell 1.3 per cent in the month indicating that slightly fewer consumers expect unemployment to rise. Households remain highly concerned about job prospects but the recent overseas developments did not exacerbate those concerns.
These disturbing measures of job security prospects are likely to be much more aligned with Australia’s rigid industrial relations structure which now sets wages through the central mechanism of the Fair Work Commission, where not only are the minimum wages for the lowest paid determined but also minimum wages for thousands of other job classifications as well as fixing relationships across job classifications.
With Australian workplace agreements – which were much more likely to allow an alignment between productivity and compensation while providing employers and workers with flexibility – being phased out in favour of a rigid centralised format for setting wages and relativities across industries, firms’ preparedness to employ full-time workers is likely to be constrained.
Combined with rigid unfair dismissal laws particularly for small businesses (those with more than 15 employees) our survey results, which now show heightened concerns around job prospects, are hardly surprising in a world where firms are generally facing difficult demand conditions.
Sentiment around housing was, arguably, the most significant development in the survey. The index tracking assessments of ‘time to buy a dwelling’ tumbled 16.7 per cent. That index is now at its lowest level since June 2010.
The weakest read in this index came in New South Wales where it fell 19 per cent to its lowest level since February 2008 when mortgage interest rates were peaking and there were clear early signs of significant difficulties in the global financial system. It is likely that this sentiment is being driven by affordability concerns and may be signalling a slowdown in the Sydney property market.
Certainly our research around the relationship between housing sentiment and general turnover in the market makes a fairly convincing case for a marked slowdown in conditions.
However that relationship and the signals from the survey are likely to be capturing the sentiment of the owner-occupier rather than the investor. For example, new lending to the owner-occupier over the last year has fallen by 2 per cent whereas new lending to investors has surged by 19 per cent. Investors tend to be less sensitive to income pressures and, arguably, affordability.
In addition, strong buying by investors based abroad, particularly China, is also reportedly a significant factor driving some markets. With prices showing strong momentum in key markets and mortgage rates low, in some cases below gross rental yields, the main drivers of activity in this segment remain broadly positive. We also expect that with anti-corruption policies likely to remain firmly entrenched in China and gradual progress towards capital account reform, these international investors are likely to remain important factors in markets for the foreseeable future.
The most likely constraint on these investors will come from Australian government policy, which should be targeted at existing properties rather than new developments.
However, some softening in investor activity looks likely. APRA and the RBA have introduced macro-prudential measures aimed at managing risks in this segment (capping investor lending growth to 10 per cent and tightening criteria).
The federal government has also ‘tightened up’ some conditions around foreign buying with measures aimed at improving monitoring, increased penalties for illegal purchases and a high profile prosecution. How these and the aforementioned regulatory measures impact investor demand is difficult to assess and, as such, is a key risk to the outlook for house prices.
Despite these affordability concerns respondents expect even further house price increases. The Westpac Melbourne Institute Index of House Price Expectations rose by 8.2 per cent in the July survey, including an 8.1 per cent increase in the NSW index.
The Reserve Bank board next meets on August 4. The board has demonstrated recently that at these low levels of rates any further cuts will be gradual and most likely timed for the months of February; May; August and November when the Bank revises its forecasts for growth and inflation. Having cut rates in both February and May the August meeting does become a ‘live’ event.
However, we expect that it is very unlikely the board will decide to cut rates in August. In May, it was still forecasting above trend growth in 2016 of 3.25 per cent and we expect that the catalyst for any decision to cut rates would come from a substantial downward revision to its growth forecast for 2016 to ‘below trend’ territory. That decision will be largely influenced by the assessed momentum in the economy in the second half of this year and developments in the labour market.
With insufficient available evidence on the former and, for now, the unemployment rate having stabilised, there is almost no case for an August move.
The significance of the August meeting for markets will be around the bank’s decision on its assumptions for the interest rate path. Note that in February the RBA diverged from its usual practice of forecasting steady interest rates and chose “market pricing”. At the time markets had a full second rate cut priced in.
In May, the RBA retained that approach and is likely to continue with that policy. If current pricing prevails by that time (around 20 bps of cuts expected by November), markets will be emboldened to strengthen their rate cut views.
However we would see that approach ensuring downward pressure on the Australian dollar while retaining a “standard” policy approach. Therefore despite current market expectations and a likely encouraging signal in August, we would still put a limited chance of a move in November.
In fact, we are comfortable to retain the view that rates will remain on hold for the remainder of this year and throughout 2016.
Bill Evans is chief economist at Westpac.