Services sector activity hits 11 month high, consumer confidence up: CommSec's Craig James

EXPERT OBSERVER

The services sector dominates the Australian economy, representing around 70 per cent of gross domestic product (GDP) and employing four out of five Aussies. According to the AiGroup, activity in the services sector expanded at its fastest rate in 11 months in October.

The pace of expansion has picked up for three successive months with sales, new orders, employment and deliveries all up during October in positive signs that some ‘green shoots’ may finally be emerging for the Aussie economy.

Last week, the Aussie dollar rose in value by 1.2 per cent against the greenback – the best weekly gain since early September - hitting intra-day highs of US69.30 cents on October 31 due to US-China trade deal optimism. The Aussie dollar had been stuck in a tight US67-68 cent range since August.

While Reserve Bank policymakers would prefer a lower Aussie dollar to support economic growth, consumers on the other hand generally benefit from a cheapening in imported goods purchase costs and lower overseas travel costs, perhaps brightening shopper sentiment.

Lower unleaded petrol prices (down by 4.6-7.9 cents a litre in Sydney, Melbourne and Brisbane) and confirmation of a strengthening in October home prices (up by the most in 4½ years) could also be considered reasons for the biggest lift in consumer confidence in five weeks.

What do the figures show?

The Australian Industry Group (AiG) Performance of Services Index (PSI) rose from 51.5 points to an 11-month high of 54.2 points in October. But the ‘final’ CBA/IHS Markit Services Purchasing Managers’ Index (PMI) fell from 52.4 points in September to 50.1 points in October. A reading above 50 indicates an expansion of services sector activity.

According to the AiGroup: “Following two months of mildly positive results, October saw a substantial pickup in business conditions, and particularly sales, for services businesses. Some respondents reported strong demand from new customers and good domestic and international demand. Increased discretionary spending was evident across the consumer sectors.”

The CBA/IHS Markit October PMI data “showed little change in Australian services business activity at the start of the fourth quarter. This was accompanied by marginal sales growth, which was limited by a first decline in export demand for over two years. Business confidence subsequently dropped to the lowest since March whilst employment barely rose. Input price inflation remained solid, contributing to an accelerated rise in output charges.”

Consumer Sentiment

The weekly ANZ-Roy Morgan consumer confidence rating rose by 2.8 per cent - the biggest lift in five weeks - to 113.5 points. Sentiment is still below the average of 114.4 points held since 2014, but above the longer term average of 113.1 points held since 1990.

All five of the major components of the index rose last week:

The estimate of family finances compared with a year ago was up from +12.5 points to +14.3 points;

The estimate of family finances over the next year was up from +24.5 points to +27.7 points;

Economic conditions over the next 12 months was up from -7.9 points to -5.5 points;

Economic conditions over the next 5 years was up from -1.0 point to +5.7 points;

The measure of whether it was a good time to buy a major household item was up from +23.9 points to +25.5 points.

The measure of inflation expectations was unchanged at 3.9 per cent.

What are the implications for interest rates and investors?

It appears that the all-important Aussie services sector growth engine could be reaching a ‘gentle turning point’ – as hoped for by the Reserve Bank. The AiGroup reported that “there are tentative signs that lower interest rates and recently paid tax rebates are (very mildly) boosting discretionary local retail spending.” The commentary will be ‘music to the ears’ of policymakers after the release of yesterday’s disappointing September retail trade report.

The Reserve Bank is expected to sit back for a few months before deciding the next move in interest rates with no policy change expected later today by CommBank Group economists. We’ve pencilled in a cut in February 2020.

Policymakers will be watching the recent upward movement in the Aussie dollar very closely. The currency is closely correlated to China’s offshore currency – the Yuan – which has been heading higher against the greenback on increasing trade optimism. The central bank will be concerned with the Aussie’s recent momentum - due to US rate cuts and improving risk sentiment - with any push-through the US70 cent ‘ceiling’ potentially constraining already weak economic activity.

CRAIG JAMES is the Chief Economist at CommSec