A bad time for households to tighten the purse strings

Growth continues to be driven largely by resource exports, leaving the economy vulnerable to the whims of China. Household consumption is needed to support growth, but the outlook is far from pretty.

Real wages are declining and budget cuts are imminent; consumer confidence is still weak and unemployment remains elevated. The outlook for household spending is beginning to look downright ugly and that leaves us particularly vulnerable to risks in China.

Retail sales rose by 0.2 per cent in April, slightly weaker than market expectations, to be 5.7 per cent higher over the year. This marks the third consecutive month of subpar growth, following strong growth over the second half of 2013. Retail sales in April were 0.3 per cent above the March quarter average.

Graph for A bad time for households to tighten the purse strings

Spending at cafes and restaurants rose by 11.4 per cent over the year, presumably driven by dreadful reality shows, while food retailing has increased by a healthy 5.3 per cent. Combined with department stores, these three categories drove growth in April. This more than offset a fall in spending on household goods and “other” retailing.

Graph for A bad time for households to tighten the purse strings

Spending on alcohol rose by 1.1 per cent in April, possibly reflecting the unusual timing of Easter that allowed many Australians to take an extended break from Easter to the Anzac Day long weekend. Although the ABS seasonal adjustment program does an excellent job identifying seasonal and holiday effects on spending, it is possible that the unusual timing left some residual seasonality in the series, which boosted items such as alcohol.

At the state level, growth was largely driven by Victoria, which more than offset a moderate decline in Queensland. The other states all recorded fairly modest gains or losses during April, none of which contributed or subtracted noticeably from national growth.

Over the past year, New South Wales and Victoria have accounted for 75 per cent of retail sales growth. This is significantly greater than their share of total retail spending (around 56 per cent in April). Presumably this reflects strong asset growth -- both of the housing and equity variety -- in Australia’s two main financial hubs.

With a subdued labour market and consumer confidence plummeting, the outlook for household spending is far from pretty. Add in declining real wages and budget cuts that target those with the highest propensity to consume and it begins to look ugly.

Who could blame a household for tightening its purse strings?

The rebalancing of the Australia economy was built on three pillars: consumption, residential investment and exports. I comprehensively dismantled the belief that residential construction could drive growth yesterday and today a second pillar is looking decidedly shaky (Don’t dwell on the myth of a housing construction boom, June 2).

Luckily the third pillar remains sturdy, with net exports set to contribute around 1.4 percentage points to March quarter real GDP. The outlook for exports remains fairly strong, with a number of mining projects transitioning from the investment to the production stage.

But with exports our main driver of growth, we leave ourselves particularly vulnerable to the whims of the Chinese economy. This hasn’t caused any problems thus far, but recent speculation regarding Chinese property and growth is a risk that we cannot ignore.

The reality is that an economy driven largely by resource exports will not be enough to offset the eventual decline in mining investment. Australia desperately needs a healthy and vibrant household sector to support growth. Household consumption accounts for around 53 per cent of real GDP and, without solid consumption growth, it is awfully difficult for the Australian economy to grow at or above trend for any length of time.

Household spending has slowed significantly over the past three months, following solid growth throughout 2013. With real wages declining and budget cuts putting pressure on household budgets, it is likely that consumption will remain subdued for some time.