This is why consumers are gloomy

Stockmarket

This week has not been a good one for the economy with consumer sentiment remaining mired in pessimism and business confidence dropping sharply to now be below its long run average.

When consumers are pessimistic and business confidence is weak, the overall performance of the economy is generally sub-par and that is where economic conditions are at the moment.

The Westpac measure of consumer sentiment was 97.5 index points in September where a reading below 100 indicated more pessimists than optimists in the economy.

Consumer sentiment has been below 100 for 10 straight months which is consistent with sluggish household spending and an associated soft economy. The last time consumer sentiment was this pessimistic for this long was during the depth of the GFC.

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The NAB measure of business confidence dropped 7 points in August to just +5 points which, if sustained, will be a precursor to weaker business activity. NAB indicated that the biggest drivers of the deterioration in business confidence was a lack of consumer demand, government policy intransigence on energy policy and weak wages.

None of these issues appear likely to change in the short to medium term which makes the recent budget forecasts for growth, unemployment and wages seem unduly optimistic.

There was mixed news with the labour force data for August which showed a decent lift in employment, but a still high 5.6 per cent unemployment rate and a hefty 8.6 per cent of the workforce underemployed. Underemployment measures people who have a job but wish to work more hours so the fact it is still high suggests a lot of slack in the labour market.

Indeed, the labour market remains a long way from full capacity, which in economic jargon terms, means that wages growth is likely to remain very weak and with that spending power curtailed.

The unemployment rate has averaged 5.7 per cent over the past year, well above the average of just 4.6 per cent in years 2006, 2007 and 2008.

Missing link?

The missing link is economic growth. When the unemployment rate was below 5 per cent for that extended period of time, annual GDP growth was generally in the 3 to 4 per cent range. Firms were hiring at a rapid pace, wages growth was strong and business profits were booming.

Now GDP growth is between 1.75 per cent and 2.75 per cent, wages growth is at record lows and profits are only fair.

With the mediocre performance of the labour market and the tone of pessimism in the economy, hopes for a sustained pick up in GDP growth to 3 per cent or more are likely to be dashed.

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It is all not bad news, it must be noted. The economy is nowhere near recession simply because of decent growth in export volumes, higher infrastructure spending and a bottoming out of the business investment cycle. It was also encouraging to see the NAB Business Survey show a solid level for business conditions which suggests actual activity is, for the moment, more positive than confidence about the future.

But these strong bits of the economy need to be stronger still and need to be joined by a pick up in activity in consumer spending and dwelling construction, neither of which looks likely to materialise until well into 2018, at best.