Bill's Bites: Inflation weighs on sentiment

Westpac chief economist Bill Evans discusses how inflation weights on sentiment

09 February, 2022

The 1.3 per cent fall in February’s Westpac-Melbourne Institute Index of Consumer Sentiment is quite surprising, given the easing disruptions from the Omicron variant and strengthening labour market in the past month.  

Indeed, we’ve seen spectacularly strong employment data, and that's shown up in our measure of how people feel about their job security, which is at its second-best level in 10 years. 

So, why did overall consumer sentiment fall? 

Well, despite improved expectations around the outlook for the economy over the next 12 months, which lifted by 2.4 per cent, this was more than offset by increased pressure on family finances. 

The ‘finances vs a year ago’ sub-index slumped by 9.2 per cent (more than reversing the surprise 7.5 per cent lift in January) while the ‘finances, next 12 months’ sub-index fell by 1.5 per cent to be down by 4.3 per cent since December.

The most likely explanations for these elevated pressures on finances are around Omicron-related disruptions to activity and earnings at the start of the year, along with the rising cost of living and the prospect of rising interest rates.

Petrol prices have lifted by 15 per cent over the last two months. Recent consumer price index updates also show a broader lift in prices since mid-2021 that looks to have continued into early 2022, exacerbated by the collision of virus-related supply chain disruptions with surging demand.

The largest fall in confidence was among those respondents in younger age groups, renters, retirees, and those on very low incomes. All of these sub-groups tend to be more sensitive to increases in the cost of living, particularly for ‘staples’ such as food and transport.

The other issue was around the outlook for interest rates. Now 66 per cent of respondents expect interest rates to rise during the next 12 months, up from 55 per cent in January, and more than one in four think they will rise by more than one per cent.  This is the most pessimistic consumers have been about the interest rate outlook since August 2011, although on that occasion, rate hikes actually failed to materialise. 

Offsetting all of that was an incredible recovery in the outlook for house prices, up 8.7 per cent, having fallen for the last four months by 9.4 per cent. 

This amazing resilience in confidence in the housing market is what we’ll be watching closely as we move into a tightening cycle where the central bank begins to raise rates – and we expect the first lift to come in August.