Australia | Oct 14 2009
By Chris Shaw
The recent increase in interest rates by the Reserve Bank of Australia (RBA) did little to dent Australian consumer sentiment as the Westpac - Melbourne Institute Index of Consumer Sentiment rose by 1.7% in October to a reading of 121.4, compared to the 119.3 reading of September.
Westpac chief economist Bill Evans suggests the result shouldn’t come as any great surprise as the evidence from the last interest rate tightening cycle that began in May of 2002 shows consumer sentiment is quite resilient to interest rate increases while rates remain at very low levels. This is still the case currently. Given this Evans suggests the next increase in official interest rates, which is expected at the next RBA meeting early next month, should also not have much of an impact on sentiment levels.
But once rates move higher, Evans notes the impact can be far more significant, as in the previous cycle the increases that pushed the standard variable rate from 6.55% to 7.05% in two months saw sentiment fall by more than 5%, while the next rate hike saw a further 15% fall in sentiment.
What is of interest this time around, in Evans’s view, is the current debt to income ratio for households is around 155%, well above the 130% level of 2003 when the previous rate hike cycle was underway. This suggests households should be even more sensitive to increases in the standard variable rate in coming months, with a level of 3.5% on the cash rate likely to be a trigger level above which sentiment may begin to respond adversely to further rate hikes.
Interest rates won’t be the only variable though, as Evans notes other factors such as the level of the share market, petrol prices and the Australian dollar will also impact on sentiment. Here recent moves have largely been favourable, with equities and the AUD stronger and petrol prices declining since the last survey.
A resilient labour market has also been good for sentiment, Evans noting the fall in the unemployment rate from 5.8% to 5.7% in September has strengthened the conviction of households their jobs are safe or at least safer than they thought a few months ago. Some caution would still be appropriate in his view, as while some in the market are now suggesting unemployment has peaked, the bank doesn’t agree this is the case.
One point of interest in the latest data, in Evans’s view, is the continued divergence between the Expectations Index and the Current Conditions Index. The former is now at its highest levels since the survey began in 1975 following a rise of 1.1% in October, while the gain of 2.7% in the Current Conditions Index has it still well below previous peaks.
Given expectations remain significantly higher than the assessment of current conditions, Evans suggests there is some doubt about the extent to which the improved mood feeds through to actual spending levels. In the past a more even mix of expectations and current conditions drove spending higher, but the current gap may keep spending levels constrained.
News with respect to housing was mixed in the survey, as there was an 11% fall in households’ assessment of whether this was a good time to buy a house, sending this reading to its lowest level since November of 2008. In contrast, Evans notes expectations for house prices remain positive, with 74% of respondents expecting prices to rise compared to 53% back in July.
Sentiment with respect to family finances compared to a year ago improved slightly, while there was also a minor increase in favour of the view now is a good time to be buying major household items. As well, Evans notes opinions on economic conditions over the next year also improved, rising by 5.7%, while the five-year outlook actually fell by 2.6%.
At the RBA meeting on November 3rd Evans expects another 0.25% increase in the cash rate, with an accompanying statement more rate hikes are likely. The next rate hike shouldn’t impact on sentiment, though as previously mentioned Evans sees subsequent hikes as causing sentiment to turn down.