There is a stark difference in mood in the economy.
Key points:
- Consumers are deeply pessimistic, but still spending
- Business confidence has improved
- However, economists think spending will start to drop as interest rate increases bite
Businesses are enjoying prosperous conditions with high profits and rising confidence, but consumer sentiment has fallen into deeply negative territory.
In fact, the gap between business confidence and the gloomy consumer sentiment is the largest on record.
Despite that, households are still spending money as though they’re optimistic about the future, and it’s complicating the economic outlook.
But economists say it’s likely that rising inflation and uncertainty will soon begin to weigh on spending, and when that tipping point occurs we may see a real slow-down in economic activity.
Many expect that slowdown to occur next year.
Business confidence rises, despite headwinds
The latest monthly surveys on business and consumer confidence were released on Tuesday.
The NAB monthly business survey showed Australian businesses reported very positive conditions last month.
Businesses said they were enjoying strong trading conditions, high levels of profitability, and more demand for staff.
It pushed business confidence back above its long-term average, and comes despite a steep increase in purchase costs and labor costs.
“How long this can persist before demand begins to fall is a key uncertainty for the economy,” Commonwealth Bank economist Belinda Allen said on Tuesday.
“The bounce in confidence and conditions was somewhat surprising to us given the combined headwinds of high inflation, rising interest rates and depressed consumer sentiment.
“It is our view that the multitude of headwinds are likely to weigh on economic activity throughout the second half of this year.
“As such, we expect business confidence and conditions to ease as consumers tighten their budgets in what is an increasingly complex and challenging economic environment,” she said.
Diana Mousina, a senior economist at AMP Capital, said businesses had been able to push some of their rising costs onto customers without hurting their profits in recent months, but that situation may not last for much longer.
She said when that point occurred, it could show up in declining business confidence.
“While businesses have so far been able to pass on higher prices to consumers, this can’t last as consumer spending power has been hit from rate rises and high inflation,” she said.
“The monthly confidence surveys showed a divergence between unhappy consumers and upbeat businesses.
“Also, while selling prices have risen, purchase and labor costs are rising faster which indicates some potential margin pressure for firms.
“As consumer spending volumes decline, which is just starting now, business confidence and conditions should also fail.”
Consumer sentiment becomes deeply negative
The Westpac-Melbourne Institute survey of consumer confidence showed households had become deeply pessimistic.
Bill Evans, Westpac chief economist, said the rapid decline in sentiment last month pushed household confidence to levels similar to the lows of COVID and the global financial crisis.
However, he said they were still well above the lows reached in the recession of the early 1990s.
“Since the recent peak in November 2021 the Index has fallen every month for a cumulative decrease of 22.9 per cent,” Mr Evans said.
He said interest rate increases are now weighing noticeably on confidence after the Reserve Bank delivered yet another 0.5 per cent rate increase last week.
“Respondents holding a mortgage were particularly unnerved by the rate rise,” Mr Evans said.
“Their confidence fell by 8.9 per cent compared to modest moves from tenants (0.2 per cent) and those owners who do not have a mortgage (-2.1 per cent),” he said.
Curiously, economists say households are still spending as though they’re confident about the future and it’s complicating the economic outlook, but they didn’t expect that divergence to last.
“Consumers are feeling abnormally pessimistic at the moment,” said Ms Allen.
“The combination of higher inflation, aggressive interest rate hikes and falling home prices together have contributed to very low levels of sentiment.
“[It] raises the risk that spending growth will slow more materially from here,” she said.
Where to fromhere?
Stephen Wu, an economist from Commonwealth Bank, said consumer confidence and spending typically moved together, so the large gap that had developed between the two was puzzling.
“On one hand, we have seen consumer sentiment decline to very low levels that are consistent with major economic disruptions,” he said.
“But on the other hand, consumption growth was robust in the first quarter of 2022, and looks to have been fairly solid in the June quarter.
However, he said data suggested rising uncertainty and inflation were two key factors pushing sentiment lower, and internal CBA data show there’s a clear moderation in spending growth already underway, with spending declining noticeably for discretionary goods in recent months.
“That is consistent with households’ budgets feeling the pinch,” he said.
“We do expect the combination of materially higher mortgage rates, lower home prices, and rising cost of living pressures to put downward pressure on real consumer spending.
“We anticipate softer spending will drive below-trend economic growth over 2023,” he said.
Ms Mousina from AMP Capital agreed.
“The monthly confidence surveys showed a divergence between unhappy consumers and upbeat businesses,” she said.
“The strength in the business survey is unlikely to continue as consumer spending volumes start to weaken and margin pressure accelerates.”
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