The pickup in consumer sentiment in the second half of 2024 has carried over into the new year, although the modest pace of improvement should give the Reserve Bank few grounds for concern on the inflation outlook.
The Westpac-Melbourne Institute sentiment index rose 2.6 per cent over the three months to January to 92.1, having languished in the 80s for much of the past two years. However, it remains below the 100 level which points to there being more pessimists than optimists.
Westpac’s proprietary data tells a similar story, with our card tracker and consumer panel both showing that spending has picked up a little over the past six months. Still, we also continue to see households opting to save most of the income boost they received from Stage 3 tax cuts which took effect on July 1 last year.
From the RBA’s perspective this is close to a Goldilocks scenario, in terms of being not too hot or too cold. The central bank would have had concerns that the tax cuts could have unleashed a spending spree, but while there have been some points of strength – for example around the Black Friday sales – overall, the pickup in spending has been more modest.
It’s uncertain whether this trend of gradual improvement will continue over the course of 2025 and there have already been a couple of important developments which could impact on sentiment.
Firstly, the December quarter inflation report, published in January, has in our view cleared the way to the RBA cutting the cash rate at its February Board meeting. That will provide further cost-of-living relief to households.
The expectation that interest rates would start to move lower has been an important support for sentiment over the past six months and seeing that begin to play out should go down well with consumers.
Trump factor
On a less positive note, the external backdrop is a lot more unsettled. The inauguration of President Trump has heralded a flurry of activity, most notably the early salvos in a potential trade war between the U.S. and its major trading partners.
Australia may be a long way from these issues, but we’ve already seen some sensitivity: sentiment had a wobble in December and January, despite the index posting an overall gain for the three months to end-January. The Trump factor may also have an impact on the February survey.
As these opposing factors play out it’s likely that we’re in for a choppy period for consumer sentiment in the months ahead.
Past precedent shows that moving into a rate easing cycle is not always straightforward for sentiment. The news is usually positive, but it also depends on what expectations have been built in.
While we expect the RBA to cut in February, we also think they will take a more gradual approach to easing rather than go for rapid back-to-back moves. As such, the February sentiment survey will offer an important insight into what consumers are expecting in terms of interest rates and inflation.
The threat of global tariff increases might also play into those inflation expectations.
And we have a federal election due by the end of May, further adding to the prospect of a period of turbulence in the first half of the year.
The good news is we’re unlikely to return to those deeply pessimistic reads seen over the past couple of years. While consumers are likely to remain quite conservative over 2025, we remain confident that the recent recovery in sentiment will continue to gain traction as the year unfolds.
For a longer version of the video, including more insights from Matt, visit WestpacIQ.
Matthew is a senior economist with Westpac. His specific areas of expertise are housing markets and the Australian consumer sector. Matthew’s research has been instrumental in shaping Westpac’s views on the Australian economy, including recent calls on official interest rates. His research has provided important insights into housing market developments and the behaviours of the Australian consumer. He is the author of Westpac’s monthly Red Book report, regards as essential reading on the consumer sector. Before joining the Westpac team in 2007, Matthew held senior positions with leading economic consultancies in Australia and New Zealand.
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