THE BIG PICTURE: Why we need to watch wealth, inflation and spending

On Wednesday the latest wealth figures were released in Australia. And they made good reading. Not only did the wealth levels of Australians rise again in the latest quarter but they reached record highs.

The increase wasn’t startling – with wealth up just 0.2% in the June quarter to $5.87 trillion. But when you consider that the sharemarket retreated by almost 12% in the quarter, the fact that wealth actually rose is quite encouraging.

It is remarkable, and highlights just how well the economy has fared, that Australian consumers have gone through the global financial crisis and come out the other side with record wealth levels. CommSec estimates that wealth held in assets likes shares, homes and cars equated to $262,500 for every man, woman and child in the June quarter. That result was actually down $500 on the March 2010 record high but that was because the increase in population exceeded the growth in wealth.

So why the fuss about wealth? Certainly quite a number of economists probably don’t even realise that the latest estimates have been released. But if you are serious about working out where household spending is going, you have to some idea, not just about the level of wealth, but how it is tracking.

The Reserve Bank has estimated that a one dollar increase in sharemarket wealth boosts consumption by around 6-9 cents. And a one dollar increase in housing wealth will increase consumption by around 3 cents. This sounds small, until you consider the value of housing assets. The Reserve Bank estimates that the value of our homes stood at $4 trillion at the end of March and that the value of these assets increased by $704 billion or 21.4% over the year.

When you do the sums, this suggests that household consumption (spending) could have lifted by $21 billion over the past year, just on the back of our more costly homes. Now the Reserve Bank analysis cautioned that there would be time lags involved, that is, the estimates refer to the “long-run effect of a permanent change in wealth, which is likely to take years, rather than quarters to fully pass through to consumption.”

But the point of course is that wealth is rising – and at a fairly fast clip – and that wealth is at record highs. The lift in wealth is certainly encouraging for retailers, providing just another reason for consumers to spend. And it also wouldn’t be lost on both the Reserve Bank and Treasury. Both institutions have models of the economy and wealth is a key input into the household spending equation.

The week ahead

Inflation figures dominate the radar screen in the coming week together with a speech by the Reserve Bank Governor. But late in the week, new data on lending and home prices will also be in the spotlight.

Data on producer prices (business inflation) is released on Monday with Reserve Bank Governor, Glenn Stevens, scheduled to deliver a speech on Tuesday. The main inflation gauge – the Consumer Price index (CPI) – is issued on Wednesday. And on Friday the RP Data-Rismark home value index is released together with new home sales and private sector credit (lending) figures from the Reserve Bank.

Overall we expect there was little movement in producer inflation in the September quarter with prices up 0.3%. The Aussie dollar rose by 13% between the end of June and end of September, pushing down import costs, while oil prices were only up around 2%.

But the main attention will be on consumer prices (CPI). We expect that the headline or published growth rate for the quarter was 0.8%, driven almost entirely by higher utility charges – electricity, gas and water – as well as higher council rates. However food prices were probably restrained by favourable weather, petrol prices fell 3%, and the higher Australian dollar together with discounting by retailers pushed down prices of household good items and clothing. Education, communication and financial services prices probably didn’t budge.

Once the volatile elements are stripped out, underlying inflation was around 0.6-0.7%, depending on which measure you look at. And that suggests that the annual rate of underlying inflation would fall from around 2.7% to 2.5-2.6%.

Clearly if inflation results are in line with our expectations, it will be more difficult for the Reserve Bank to justify a rate hike in November. Still, the Reserve Bank will be updating its inflation forecasts, and if it believes that inflation is headed above 3 per cent in future, underpinned by a tight job market and rising wages, it will use this as the excuse to lift rates.

The Reserve Bank Governor will no doubt provide some hints on monetary policy strategy when he fronts the lectern two days before the inflation data is released.

Of the other data, home prices have fallen for three straight months, but the anecdotal evidence is that home prices may have edged higher in September. And private sector credit likely rose by just 0.2 per cent in September, confirming that consumers and businesses aren’t keen to borrow.

In the US, there is again a consistent flow of indicators over the coming week with the highlight probably the economic growth (GDP) data on Friday.

On Monday, existing home sales figures are released with home prices and consumer confidence on Tuesday. On Wednesday, new home sales and durable goods orders will dominate attention with the weekly jobless claims data on Friday. And on Friday, consumer sentiment and the Chicago purchasing managers index are issued alongside the economic growth figures.

Economists expect that the pace of economic growth lifted modestly in the September quarter from 1.7% to 2.4%. But given that growth around 3% is targeted to get the jobless rate down, the growth rate is unlikely to stand in the way of more quantitative easing.

Of the other data, existing and new home sales are both expected to rise by 3%; durable orders probably rose 0.8%; consumer confidence was probably little changed; and annual home price growth may have slowed from 3.2% to 2.7% in August. There will also be around half a dozen speeches by Federal Reserve officials for investors to digest.

Sharemarket

A big week ahead for profit results in the US, but the list is dominated by mid-sized and smaller firms as many of the heavyweights have already reported. Clearly the good news so far is that companies have been regularly beating expectations, providing support for the broader sharemarket.

Amongst those reporting on Monday is Texas Instruments. On Tuesday, Arcelor Mittal, Kimberly-Clark, Office Depot and U.S. Steel are on the earnings calendar. Earnings results out on Wednesday include ConocoPhillips. On Thursday, 3M and Colgate-Palmolive issue their results. And around 50 companies issue results on Friday including Merck.

Interest rates, currencies & commodities

Commodities like gold, oil, copper and nickel generally hog the headlines. But one of the more interesting stories at present is cotton. Last Friday (October 15) the price of cotton soared, and according to one report, hit the highest levels “since the American Civil War”. Certainly the price of US119.8 cents per pound exceeded the previous high set in April 1995. For some commodities, the key price driver has been the weakness of the US dollar – boosting the purchasing power of buyers in Asia and Europe.

But cotton prices are fundamentally well supported with cotton stocks the lowest in 15 years. ABARE currently expects Australian cotton exports to exceed $1 billion this financial year, up 33% on a year ago and double that of the 2008/09 year.