Something usual is happening in Australia this year.
On one hand households, as measured by the ANZ-Roy Morgan consumer confidence index, are feeling fairly downbeat with sentiment currently sitting at the lowest level seen in close to two years based off the most recent survey.
However, while households are feeling glum, that’s not the case for business with the National Australia Bank’s business confidence index suggesting that firms are pretty upbeat, boosted by operating conditions not seen since before the global financial crisis.
It’s slightly unusual, and has got more than a few asking why such wide chasm has opened up between the two.
What are businesses seeing to make them so confident that households aren’t or, to the contrary, why are businesses optimistic given consumers — their customers — are feeling downbeat?
As seen in the chart below from ANZ Bank’s Australian economics team, the gap is currently the widest that it’s been in close to a decade.
It’s a large divergence, leading many to ponder which group is right on this occasion.
Are businesses on the money, indicating that the Australian economy is strengthening, or are households right, providing an indication that growth may weaken given consumption is such a key cog in the Australian economy?
Prompted by the gap that’s opened up between the two, and perhaps the economic significance as to who will be proven right, that’s the question that economists at ANZ have attempted to answer in a research note released earlier today.
Looking back to past episodes when consumer and business sentiment have diverged, economists at the bank discovered that it’s businesses, rather than households, that tend to be correct, especially when consumers are feeling downbeat.
“For the most part, consumer confidence appears to rise toward business conditions when consumer confidence is low, rather than the other way around,” said the bank’s economics team, lead by David Plank.
“This was certainly the case in late 2002/early 2003, late 2005, through the middle of 2006, in May 2014 and, most recently, through 2015 when business conditions rose ahead of an eventual move higher in consumer confidence.”
The one exception to the recent rule was during the global financial crisis in 2008 and early 2009 when a collapse in consumer confidence led an eventual, and equally as large, decline in business confidence.
ANZ says there’s a reason why, in most instances business confidence tends to lead.
“We think the usual dominance of business conditions over consumer confidence reflects the link between business conditions and the labour market,” it says. “If businesses are in an optimistic mood then that usually flows through to the labour market, which in turn will likely boost consumer sentiment if it is low.”
The linkage between the two is easy enough to understand.
Businesses can gauge demand, and, if it’s strengthening, they have tendency to add more staff. That, in turn, improves labour market conditions, making households feel a little more confident when it comes to job security, the prospect of finding new work and, potentially down the line, faster wage increases.
And ANZ says that outcome, as it has in the past, will also arrive on this occasion.
“We think this pattern is likely to play out over the next few months, with a better performing labour market leading to a stabilisation followed by recovery in consumer sentiment,” it says.
While that offers promise on the outlook for household consumption if history does repeat, ANZ doesn’t believe that we’re about to see a surge in consumer confidence, particularly with wage growth sitting at the lowest levels on record and the likelihood that the RBA will keep interest rates unchanged for the foreseeable future.
“Even if this is correct we don’t think overall conditions will support a dramatic rise in consumer sentiment,” it says.
“We think the RBA cash rate will remain on hold, which means we won’t see a boost to sentiment from lower interest rates.
“More importantly, while the recent Wage Price Index indicates that wage growth has stopped falling and may even be starting to move higher, any pick-up is likely to be very subdued in our view.
“We think weak income growth will keep a lid on consumer sentiment for some time.”
Even if that assessment is correct, it’s still a far better outcome to the alternative where consumers become so nervous that they curb their spending, sending business confidence and economic growth lower in response.
Let’s hope that history will repeat.