THE BIG PICTURE: The New Conservatism hitting our economy

Economists have got it wrong – again – and I’m not just talking about the latest inflation data, although it is related. Rather it has been the perception that the Australian economy is barrelling along, meaning that rates would have to go up substantially over the next few months.

The last time that most economists got it wrong was just over a year ago, concluding that Australia would slip into recession like the rest of the world and that interest rates would fall to 2% or below. Of course it didn’t happen. The Reserve Bank cut interest rates to only 3% and the Government pumped money into the economy and consumers thought this was great. Most of the people we spoke to at the time, especially across regional Australia, wanted to know why there was so much gloom and doom – times were good.

In short consumers kept spending, house prices flattened but didn’t fall and businesses decided to hold onto staff, cutting hours and pay rather than people.

Fast track to the present day and Aussie consumers are feeling decidedly more uncertain. People were just starting to realise that that the global financial crisis was ending when the Reserve Bank started lifting interest rates. And this was no gentle exercise – the rate hikes were the most aggressive in 16 years.

The rate hikes together with higher utility charges have represented a major hit to budgets at a time when many have not seen their wages return to ‘normal’ levels. And businesses are still very cautious about granting pay rises. Sure, people have held onto their jobs, and are generally happy about life. But the mood is different. People aren’t willing to spend unless the goods are ‘on special’. The perception is that budgets are under pressure and people feel that they need to respond by trimming debt and cutting back on the luxuries.

This is the mood we have sensed on travels across the country in the last few months. A mood of conservatism. The simple fact is that having a job is no guarantee that people will spend. If they don’t have to spend and are still uncertain about the future, then they won’t. Thus the low reading for the CPI. There is plenty of discounting by retailers and other consumer-focussed businesses to get people into the stores and get stock moving.

It’s important to note that the ‘new conservatism’ is international. In the US, Europe and New Zealand people are making harder choices about their purchases and debt is still being shunned. In the late 1980s there was ‘irrational exuberance’, now there is ‘new conservatism’.

Clearly this trend also extends to investments as well. In the 1970s and early 1980s the sharemarket price-earnings ratio held near 10-11 rather than the long-term average of 15-16. A return to those risk preferences may be on the cards. In short, risk is out, conservatism is in.

The week ahead

The usual monthly meeting of the Reserve Bank Board is held on Tuesday. But fortunately we don’t need to devote numerous column inches to what may, or may not, go on. It is clear to all that the Reserve Bank doesn’t need to touch rates – and not just next week, it can stay on the sidelines for a number of months.

Of course, nothing comes for free – the Reserve Bank has earned its place in the sun courtesy of interest rate hikes late last year and early this year. The Reserve Bank thought underlying inflation would ease to 2.75% with the tighter rate settings and it got its forecasts spot on. The only interest in Tuesday’s meeting is what the Reserve Bank has to say about monetary policy settings – perhaps indicating a neutral stance rather than a tightening bias.

Of the economic data, it’s the usual suspects at the start of a new month. On Monday, (a bank holiday in NSW) the Performance of Manufacturing gauge is issued together with the TD Securities/Melbourne Institute monthly inflation gauge. On Tuesday, retail sales and building approvals data are released with international trade, house prices, tourism arrivals and the Performance of Services index all to be released on Wednesday. And then next Friday the Reserve Bank is again back at centre-stage with its quarterly Statement on Monetary Policy.

We expect that retail trade rose 0.4% in June while building approvals rose by 5% and the trade surplus was again large at $2 billion in June.

Turning to the US, data in the coming week could prove more pivotal than usual. The simple fact is that investors are trying to decide whether the economy is half full or half empty and the key indicators could make the minds up for many people.

On Monday the ISM manufacturing gauge is issued together with construction spending. Personal income and spending figures are released on Tuesday together with auto sales and factory orders. The ISM services gauge is released on Wednesday together with the ADP employment report. And the all-important non-farm payrolls (employment) report is issued on Friday.

Overall, economists aren’t tipping stellar results, but the data should still indicate that a slow recovery is still on track. The ISM manufacturing gauge is expected to ease from 56.2 to 55.0 and the services equivalent is seen easing from 53.8 to 53.5. Any reading over 50 indicates expansion, so the results would be encouraging.

US economists tip a 0.6% fall in construction, 0.2% rise in personal spending and 90,000 lift in private sector employment. But there is a fair degree of uncertainty in the jobs forecast with economists tipping anything between a 19,000 and 150,000 gain in employment. The jobless rate is expected around 9.5%.

Sharemarket

The US corporate earnings season winds down over the next fortnight while the Australian reporting season gets into gear. Just as we’ve seen in the US reporting season, investors will do well to dissect how the money has been made. In the US, actual profits have generally beaten analyst forecasts, but cost cutting has proved important rather than sales. And clearly that’s not a sustainable situation.

On Monday, Crane Group is expected to report, with Hills Industries and Navitas set down for Tuesday. Amongst those reporting on Wednesday are AXA Asia Pacific, West Australian Newspapers, ASG Group and Hutchison Telecommunications. On Thursday News Corp, Rio Tinto and Tabcorp are expected to releases their results, while Resmed is slated to report on Friday.

Interest rates, currencies & commodities

What a difference a week can make. Before the inflation data, financial markets thought there was a 14% chance of an August rate hike and a 30% chance of a move within two months. Now financial markets say there is a zero chance of an August rate change, and there is only a one in three chance of any lift in rates over the next six months.

Most would conclude that the Aussie dollar has taken the ‘surprise’ inflation figures in its stride. While the currency dropped almost a cent in immediate response to the data, it is still over US89 cents, and hovering not far away from the highest levels seen over the past two months. In fact the Aussie dollar has averaged US84 cents over the past three years and averaged US73 cents since floating in December 1983. As highlighted in the inflation report, the high Aussie dollar represents good and bad news. Consumers are winners from cheaper imports and overseas holidays. But domestic tourism is suffering as shown by the record six% fall in domestic travel costs – covering flights and accommodation.

While the tourism industry may not be happy about the dollar, motorists would have a different opinion. The Aussie dollar has actually been more than matching the rising oil price, keeping pump prices low. In fact the Singapore gasoline price in Australian dollar terms is at the lowest levels in seven months and $10 a barrel below the highs in May. If current levels are maintained, then motorists will be on track to record savings of around $7 on a tank of petrol. And the good news extends to the inflation rate. Again if current levels are maintained, petrol prices would be down around 3% for the September quarter, taking 0.1-0.2 percentage points off quarterly growth of the CPI.

Craig James is chief economist at CommSec