Consumer sentiment plummets 7% in May

Consumer sentiment has fallen 7% in May, with rising interest rates and housing prices causing consumers to question the viability of their household finances.

The latest Westpac-Melbourne Institute Consumer Sentiment index fell from 116.1 during April to 108 during May, with Westpac chief economist Bill Evans saying rate rises are at the heart of this month’s decline.

Economists have said there is a point at which consumer sentiment drops when interest rates become too high – Evans says that time has come, even though he and many other analysts said this point would be reached much further in the future.

The most recent rate increase, he said, has pushed the average variable mortgage rate from 7.15% to 7.4% and as a result, “we are clearly back in that range… where future rate hikes are going to hurt consumers and the index can be expected to respond accordingly”.

“We have written in the past about sensitivity points for mortgage rates above which Sentiment can be damaged quite substantially. In the last rate hike cycle that point was reached in March 2005 when the mortgage rate was increased from 7.05% to 7.3%.”

“The Index fell by 15.5% and following the seven subsequent rate hikes in that cycle the average fall in the Index was 8.5%.”

The index assessing economic outlook for the next year dropped by 17.3%, with the five year outlook falling by 10.6%. Expectations for family finances over the next year dropped 3.6%.

Evans also said his claim that rate hikes caused the drop in confidence is based on the “time to buy a dwelling index”, which dropped by 14.5% to 88.2, and is currently 35.6% below its long-term average.

“Other factors which usually influence respondents were also weak. The re-emergence of global economic nervousness would clearly also be weighing on respondents. Since the last survey the share price Index has fallen by 6.8% while the Australian dollar had fallen by 4.2%. Petrol prices were steady.”

Evans said despite the number of rate rises this year, Westpac expects the RBA to remain on hold during June based on recent statements from the board and governor Glenn Stevens.

Yesterday, in the RBA’s minutes of the May meeting, the board explained that with the official interest rate at 4.5% most variable mortgage rates should now be at an “average” level. The RBA had previously said it would push rates to more normal levels before judging their effect on the economy.

“It is clearly time for a pause. As we have seen with the Index today interest rates are now starting to bite. That has been apparent for some time with retail spending and housing finance and even employment growth is slowing down,” Evans said.

“The news from offshore is disturbing with the disruptions to global financial markets likely to impact on the global economic recovery. Indeed until we saw the disturbing evidence from the March quarter Consumer Price Index we had been expecting the Bank to remain on hold for the remainder of 2010.”

Additionally, Evans said inflation is likely to dominate the RBA’s priorities over this “early stages of the rate cycle”, leading to a rise in August.

“In 2008 a string of very high inflation reads failed to elicit a rate response from the Bank due to the onset of the global financial crisis. A second crisis, this time emanating from Europe, would cause a further delay in raising rates. However, at this stage, we expect that the most prudent approach is to assume that markets settle over the next few months.”

Most Australians believed the Federal Budget would have little impact on their day-to-day lives, according to the survey.