Sentiment soars as economy 'escapes' recession

Westpac–Melbourne Institute Index of Consumer Sentiment rose 12.7 percent in June – a “truly remarkable result” according to Chief Economist Bill Evans

Sentiment soars as economy 'escapes' recession
Sentiment soars as economy ‘escapes’ recession

The Westpac–Melbourne Institute Index of Consumer Sentiment rose by 12.7 percent to 100.1 in June – a "truly remarkable result" according to the bank’s Chief Economist Bill Evans.

"It is the second-largest recorded increase in the Index since the survey began in 1974 and the largest increase in the last 22 years," he says.

"It is very likely that the dominant factor behind this extraordinary rise was the release of the March quarter national accounts last Wednesday, which registered a small but nevertheless positive growth rate for the Australian economy in the March quarter following the contraction in the economy in the December quarter.

"That result was widely hailed in the media as indicating that Australia had avoided a recession, defined as two consecutive quarters of negative growth.

"From the consumer's perspective that was extremely encouraging news since they had already benefited from a 385 basis-point cut in the variable mortgage rate; and around $14 billion of direct government transfers with another $5 billion to come.

"The unemployment rate had actually fallen in April to 5.4 percent so on the assumption that Australia had avoided a recession and the worst had passed, consumers have become much more confident."

However, Evans warns that the positive reaction in June is probably premature.

The March quarter national accounts still portrayed a very weak economy with domestic spending falling by 1 percent – the sharpest fall since December quarter 2000.

GDP growth was positive because imports contracted by an extraordinary 7 percent allowing net exports to contribute 2.2 percentage points to GDP growth and ensuring a positive result.

"We expect this net export effect to partially reverse in the next two quarters with GDP registering consecutive negative quarters of growth a re-establishing the ‘recession’ label," he says.

"This points to a potential negative shock to sentiment when the June quarter GDP figures are released in September."

Evans adds that other factors would also have contributed to this "stunning" result.

"Driven by the consistent improvement in financial assets, particularly global share markets, consumer Sentiment has been on the rise in most of the major economies. The latest reading from the US showed a 5.5 percent increase – taking the gains from the low in February to 22 percent.

"The Index is now at its highest level since January 2008 when the unemployment rate was 4.3 percent and the economy was growing at a 4 percent pace.

"Since the authorities started providing the economy with stimulus – when the Reserve Bank unexpectedly cut rates by 0.25 percent on September 3 – the Index had only increased by around 3 percent despite the record monetary and fiscal stimulus.

"That was undoubtedly because consumers accepted that the stimulus would be associated with a recession threatening jobs and financial welfare. With those concerns apparently allayed in the eyes of consumers (optimists now slightly outnumber pessimists) this surge in the Index can be seen as a delayed response to the significant stimulus over the last nine months.

"If as we expect we are likely to see substantial increases in the unemployment rate over the next 12 months then, as we saw in the early 1990's, consumer sentiment will remain under considerable downward pressure."

Four of the five components of the Index increased. These increases were led by economic expectations with ‘economic conditions over the next 12 months’ up by 37 percent; and ‘economic conditions over the next five years’ up by 20.2 percent.

Assessments of family finances were also strong with ‘expectations of family finances over the next 12 months’ up by 11.1 percent and ‘family finances vs a year ago’ up by 8.1 percent.

The only component that fell was ‘time to buy major household items’, which was down by 1.6 percent.

"Overall the ‘current conditions’ index was up by only 2.2 percent compared with 20.7 percent for the ‘expectations’ index. That emphasis on expectations is similar to the recent result we saw for the US index when expectations were up by 10 percent and current conditions fell by 0.9 percent.

"We are of the view that the ‘current conditions’ is a more reliable indicator of the likely outlook for consumer spending. In that regard it is significant that the one component of the Index which fell was the one most closely correlated with overall consumer spending – ‘time to buy major household items’.

"That is a major qualification of the reliability of this movement in the Index for predicting consumer spending."

Westpac’s assessment that averting a recession was the main driver of the result is supported by the ‘news heard index’, which showed that 77.5 percent of respondents recalled news items on ‘economic conditions’ with the next highest categories being ‘interest rates’ on 23.9 percent and ‘international conditions’ on 19.2 percent.

There was a sharp improvement in respondents assessments of all those categories compared to the last measure in March.

"With purchases of housing and motor vehicles seen as the most cyclical components of expenditure there was further good news on ‘time to buy a dwelling’ and ‘time to buy a car’ indices. The former is up 2.5 percent since March and now 80 percent since last June. The car industry would be buoyed by an 8.7 percent increase in that Index since March and a 51 percent increase since last June," Evans says.

The increase in confidence has encouraged respondents to raise the risk profile of their investments.

The proportion of respondents who assessed banks as the wisest place for their savings fell by 5.7 ppts from 32.8 percent in March to 27.1 percent.

In contrast, the proportion of respondents who favoured shares increased by 5.6 ppts from 6.7 percent in March to 12.3 percent.

"The Reserve Bank board next meets on July 7. Westpac has assessed for some time that the bank is unlikely to deliver on its easing bias in the near future. This result only strengthens the case for rates to remain on hold.

"Uncertainties associated with the sustainability of the current stability in the global financial system, the outlook for the Australian labour market, the potential for ‘recession’ to be resurrected in the media's coverage, and pressures on banks' funding costs will encourage the bank to maintain its easing bias for some time to come," Evans concludes.

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