Chief economist update: A case for optimism

With a buoyant stock market, tax cuts, lower interest rates and a recovering housing market, one would think all Australians should have every reason to dance on the streets.

Australians, all, should be dancing on the streets to Jimmy Cliff's classic song for now.

Borrowing costs are lower, property prices appear to have bottomed, the Morrison government's tax rebate is in the mail, the stock market is up, and there are positive whispers over a US-China trade deal.

But we're not! A day after the NAB Business Survey showed a sharp drop in business confidence in June, Westpac's Consumer Sentiment Survey - conducted in the week of July 1-5 (after the RBA's second rate cut on the 2nd and the passage of the Coalition's tax cut package on the 4th) - looks worse.

Australian consumer sentiment slid from a reading of 100.7 points in June to 96.5 in July - the lowest in two years, indicating that worriers outnumber half-glass full consumers.

The details of the report showed that apart from sub-indices related to property - "time to buy a dwelling" rose by 5.4% over the month of July; "house price expectations" up by 8.9%; "time to buy a major household item" increased by 3.6% - those related to broader economic activity indicated increased pessimism.

"Family finances vs a year ago" climb by 3.0% in the month of July but, at 85.7, remained below its long-term average of 89.4). Sure, consumers may feel their finances better than last year but their spending decisions are based on how they see their future finances, employment and economic conditions.

The "Family finances next 12mths" sub-index plunged by 8.0% in the month of July. The "Unemployment Expectations Index" increased by 5.8% to a reading of 134.4 - taking it above its long-run average of 130. This suggests respondents anticipate deterioration in the labour market and is in line with the drop in business confidence indicated by the NAB Business Survey.

This is consistent with their view over the outlook for the economy. The "Economic conditions next 12mths" sub-index sank by 12.3% to 87.1 in July (below the long-run average of 107.7).

Pessimism over the economic outlook persists over the longer-term with the "Economic conditions next 5yrs" sub-index falling by 6.7% to 91.6 (although a tad higher than its long-term average of 91.3).

The RBA's back-to-back interest rate cuts (and expectations for at least one more and up to zero) could have backfired. Consumers are more worried that the RBA deemed it necessary to announce two interest rate cuts in two months.

This could turn into a vicious cycle. Pessimistic consumers won't spend, reducing business sales and profitability, lowering business confidence, halting business investment in building structures, equipment and more importantly, staff that'll lead to higher unemployment, consumer pessimism...

Zero official cash rate here we come.

However, note that monetary policy operates with a lag. In Australia, it takes about 12-18 months changes in monetary policy trickles down into general economic activity - one of the reasons I called for an RBA rate cut way back in June 2018.

The rising stock market, the stabilisation in the property market, the Morrison government's tax cut package and, of course, lower borrowing costs, would eventually ignite a positive wealth effect that should engender optimism and by extension, spending among consumers and businesses.

Read more: NAB Business SurveyCoalitionConsumer Sentiment SurveyWestpac
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