THE WEEK AHEAD: RBA watching cautious consumers closely

Each quarter the authors of the consumer sentiment report (Westpac and the Melbourne Institute) ask respondents for their choice of the wisest place to put new savings. The results don’t get the attention they deserve as the figures provide key insights into consumer and investor behaviour.

Ranked as the number one place to put savings is bank deposits, nominated by 26.7% of respondents. Clearly safety is uppermost in consumer minds at present because other investments have provided better long-term returns in the past. The shift in favour of bank deposits began in late 2007 after the sharemarket peaked and interest rates were in the midst of their push to 13-year highs.

The second highest ranking was given to paying debt. In the September quarter 25.5% of respondents thought that was the wisest place for new savings was to reduce outstanding debt. While the result wasn’t a surprise, (the choice of debt repayment has been gradually rising over time) the surprise was that debt repayment finished a close second to bank deposits. Debt repayment has never taken top spot for the wisest place to put savings, but the top ranking is in sight.

The results help explain why people are so confident at present but are seemingly not spending. Consumers are happy with the state of their finances and the overall economy. But just because finances are in good shape, doesn’t mean that consumers are prepared to spend. The GFC has further reinforced a mood of conservatism among Aussie consumers, and it is likely to take a more extended period of good economic news to change the mind-set.

This conservative approach taken by consumers on debt and spending hasn’t just materialised during the period of the GFC. Rather debt repayment has been in vogue since 2005, taking on increased importance over 2006 and 2007 as interest rates continued their ascent.

The fact that Aussie consumers are actually fairly conservative in their approach to spending and debt runs counter to established thinking. The general perception is that Aussie consumers have debt up to their eyeballs and spend like there is no tomorrow. But the proportion of personal finance going to debt consolidation or refinancing is currently at record (22-year) highs. And the average credit card balance is falling for the first time in records stretching back over 14 years.

Consumers also haven’t just been trimming debt – spending is also growing at a slower pace. Over the past five years retail trade has grown at an average annual rate of 5.2%, well down on the decade average of 6.2% and 15-year average of 6.0%. Clearly if this new found conservatism continues, some retailers – especially those selling discretionary or non-essential goods – will continue to struggle over the next year.

The week ahead

At this stage the economic calendar for the coming week looks fairly straight-forward. That is, there will be the usual spattering of economic data, while the Reserve Bank also publishes minutes of its last board meeting. But the fly-in-the-ointment is that the final Budget outcome is due sometime before the end of September. So it’s a case of watch this space.

In terms of the economic data, second-tier indicators dominate the calendar. On Monday lending finance figures are released with dwelling commencements on Tuesday. Minutes of the September 1 Reserve Bank Board meeting are also released on Tuesday while the Reserve Bank Bulletin is issued on Thursday together with data on imports.

Usually the lending finance figures get passing glances at best from market economists. But given that the Reserve Bank wants to see improvement in the balance sheets of financial institutions before hiking rates, then the lending figures deserve more than a passing glance. The data covers new commercial, personal and lease lending. At present there are more signs of de-leveraging than indications that borrowers are keen to take on more debt or that lenders are keen to borrow. Until more ‘normal’ conditions emerge, the Reserve Bank will be reluctant about lifting interest rates.

Investors will get further insights into Reserve Bank ‘hot button’ issues when the Board minutes are published on Tuesday. Hopefully these minutes will serve to reduce speculation about the likelihood of near-term rate increases.

The Reserve Bank Bulletin is issued on Thursday and generally the main interest is in the monthly credit card and debit card statistics. Consumers have been cutting back credit card use over the past year, preferring instead to use their own money in buying goods. And that trend probably remained in place in July.

But the Reserve Bank Bulletin may also be interesting reading for other reasons. The June quarter figures on impaired assets (bad loans) at banks haven’t been published as yet. If the data is forthcoming on Thursday it will provide more insights into the strength of bank balance sheets.

In the US, a bevy of key indicators are scheduled to be released over the coming week. On Tuesday data on producer prices and retail sales are expected with consumer prices, industrial production and capital flows on Wednesday. On Thursday figures on housing stats are released together with the Philadelphia Fed index.

Investors shouldn’t expect the US economic indicators to show dramatic improvement. Production probably rose 0.5% for the second straight month with retail sales (non-auto) edging up 0.3% in August. And there should be further confirmation that the housing market bottomed back in April. New data should show housing starts rose 3% to a 600,000 annual rate in August.

Sharemarket

Over the past six months CommSec has maintained a positive outlook on the Australian economy and therefore prospects for the sharemarket. Our confidence levels certainly improved markedly in March after the US Government and Federal Reserve finally gave top priority to healing the financial system.

But interestingly we now find that our outlook on the sharemarket lags behind that of a number of other analysts. We forecast the ASX 200 to reach 4,650 by end year with 4,900 points factored in for June 2010. Some analysts expect to see 5,000 points by Christmas. Our concern is that the global healing process is still in its early days. And at some point central banks have to lift interest rates from near zero back to more normal levels. There is always the potential for things to go wrong in the early days of rate ‘normalisation’, thus our cautious stance.

Interest rates

Pricing on the overnight indexed swap market suggests there is around a 34% chance of a quarter percent rate hike by December. That sounds about right. And participants are generally convinced that the first rate hike will be delivered by February or March – the 5-month rate OIS rate stands at 3.20%. It is important to note that bank bill swap rates stand 31 basis points above the cash rate, so once the Reserve Bank does move, it will be merely validating market rates.

Currencies & commodities

The CBA currency strategists have lifted their targets for the Aussie dollar. The currency gurus now expect to see the Aussie hovering near US87 cents by end year with the currency lifting to US89 cents by March 2010 and US91 cents by June 2010.

A key factor driving the upgrade of forecasts is the out-performance of the Australian economy. Australian interest rates are already high, but if the cash rate starts its ascent early next year as we suspect, then the Aussie will prove even more attractive to foreign investors. Solid growth in the Chinese economy is also assumed, keeping the Aussie in demand. And it is also assumed that the US dollar will remain depressed on the likelihood of a flat or ‘U-shaped’ economic recovery.

Craig James if chief economist at CommSec.