Saul Eslake is out with a note this morning probing the recent rebounds in confidence:
Confidence levels in the business and household sectors have become increasingly important in determining whether the economy has potentially reached a turning point. This is because a sustained upswing in confidence should be a precursor to improved employment outcomes and a recovery in non-mining investment. And therefore they have also become a key bellwether for the stance of monetary policy over coming months. However, despite sharp increases in recent data, at this stage we suggest that it is too soon to conclude whether the recovery in confidence will be sustained. If it does indeed wane over the coming months we expect that the RBA will have to ease monetary policy again early next year and likely leave rates lower for longer.
Business confidence spikes, but consumers pull back
Business confidence rose sharply in the wake of September’s Federal election. However underlying conditions have not improved markedly and the hiring intentions sub-index continues to point to increases in the unemployment rate. Consumer confidence failed to build on post-election gains easing marginally as household concerns around their finances weighed on sentiment.
Weak employment continues, but unemployment rate falls
Labour force data showed a relatively soft gain in employment in September. Especially in light of the boost that it likely received by temporary employment due to the Federal election. Nonetheless the unemployment rate fell to a four month low of 5.6% as participation fell yet again – to the lowest rate since November 2006. We again note that this fall in participation is cyclical and as such is weakening household income growth and spending.
Housing finance and RBA minutes next week
The RBA minutes will be little changed, if at all, from recent communications. It remains on a short term neutral footing to assess business and consumer confidence. Yet the broader medium term easing bias that RBA has will persist. We note that mining investment as a proportion of GDP is poised to decline and non-mining investment has shown few signs as yet of picking up. The rebalancing of growth has therefore not progressed to any significant extent and the RBA will need to stand ready to support this process if the A$ remains elevated and if business confidence wanes.
Eslake goes on for business confidence:
The better regarded NAB survey, (that does separate activity and confidence) did show a sharp increase in confidence in September. This was building on a rise seen in August as pre-election opinion polls pointed to a change in government.
This measure now currently sits at its highest level since March 2010. Further the difference between confidence and conditions reached its widest point since August 2001 during the period in which the economy was recovering from the negative impact of the bursting of the “Dot-com” bubble. Yet this difference rarely persists and historically a rise in confidence has been a precursor to improved conditions. However a higher degree of uncertainty around this relationship remains in the current economic and political environment. The perceived improvement in the political environment has done nothing as yet to improve conditions as no policy reforms have as yet been implemented. Further, policy- makers have little influence to bring down the elevated A$ that continues to be an impediment to growth and investment in non-mining sectors.
A possible quick win for the Coalition government would be the abolition of the carbon tax before the new senate is installed in mid-2014. This is especially true as it now seems certain the Coalition has the numbers to get this policy through the upper house. This would not only be a positive for energy intensive industries, but at the margin be a positive for retail spending as household compensation for the tax will continue. However such a move by the government would likely be blocked by the combined Labor-Greens vote and will have to wait until mid next year for no constructive purpose.
And for households:
The rise in consumer sentiment may not last
The changes in policy that are likely to be delivered by the government are expected by the business sector to be a positive for them. However, they are not expected to be unambiguously positive for households. And perhaps this was reflected in the decline in consumer confidence in October following the spike that was prompted by the change in government.Indeed despite interest rates being cut 225bp since 2011 sentiment towards current family finances remains below average. And households view of their finances over the next year, despite improving are also sitting at the long term average.
The change in government will a positive for some households but negative for others and therefore could weigh on sentiment. The paid parental leave scheme will be relatively generous when it begins in mid-2015. Yet shorter-term, the abolition of the carbon tax, which should result in lower electricity and gas prices, could free up income that otherwise would have been spent on non-discretionary utilities. Also, the government-provided compensation payments to households when the tax was first introduced will continue.
Yet the new government will also abolish the $820 per year received by eligible families via the School Kids Bonus scheme, reducing household income by around $1bn in 2013-14. Nonetheless the income tax cuts and increases in pension and other benefits (apart from the “School Kids’ Bonus”) which the previous government put in place will likely remain so. Therefore we expect that that the net effect of all the changes will be to provide a marginal boost to household incomes overall from the government. However,this is will not be enough to offset the decline in income growth caused by higher unemployment and slowing wages growth.
The government’s decision to delay the release of the MYEFO (Mid-Year Economic & Fiscal Outlook), its usual late in the year budget update, has added to speculation that it may have to keep a spending tight.This is supported by the expectation that that the fiscal position has deteriorated further since the pre-election update. This could be negative for both households and the business sector as any additional spending will be limited. And this is before the fiscal balance is actively brought back to surplus over subsequent years.
If household finances are not expected to improve then the recent increase in consumer sentiment that is based on the so far positive attitude towards the new government may retrace. As such we anticipate sentiment will be somewhat inconsistent over coming months, driven by domestic and foreign headlines,rather than building on recent gains.
Further economic conditions more broadly will also weigh on households. In particular the increase in the unemployment rate will keep confidence subdued. And this legitimate concern that households have is reflected by unemployment expectations remaining elevated (Chart 12). We expect that lack of job security and weaker household income growth will outweigh any utility houses may get from rising asset prices. Indeed for the approximately one third of households that rent, those that do so in the hope of entering the housing market are being adversely impacted by rising house prices as this side of the affordability equation continues to deteriorate for them.
Fair enough. My base case is that confidence will wane. In fact, that it should, until competitiveness improves. Confidence without that is temporary and even dangerous. The reason behind that case is pretty simple. Even with a housing construction boom, there is no way it will offset the prospective falls in capital investment elsewhere in the economy:
And so far the signs are we’ll only see a modest pickup in investment. Rents are also falling across commercial property owing to a glut – though prices are rising on cheap debt – so there’ll be little construction there either.
Some argue that net exports will fill the growth hole, and they will to an extent, but they are an accounting entry, not real activity, and so support much fewer jobs than capital investment led growth. That leads to lower confidence over time as the labour market remains soft and incomes stagnate despite macroeconomic growth.
The two ways around it are to boost confidence and get the private sector borrowing and spending again via rising house prices. Which can run for a while but will soon enough bump into credit constraints. Or to boost competitiveness, and attract genuine investment.
It’s a no-brainer, really. One we somehow manage to ignore!
