Downside risks to consumer spending
Thanks to rising house and share prices, household wealth has recovered strongly in recent years. According to the latest estimates by the Reserve Bank of Australia, the household net-wealth to disposable income ratio reached a post-financial crisis high of 650% in the June quarter.
Rising wealth is one of the great hopes for the economy. Despite a projected rise in the unemployment rate to 6.25%, the Federal Government forecast in the May Budget that consumer spending would rise by 3% this financial year – more than GDP growth of 2.5% – as households respond to rising wealth by cutting back their saving ratio. This so-called “wealth effect” is consistent with the broadly inverse relationship between the household saving rate and net-wealth evident over recent decades.
That said, the chart below shows that the saving ratio has already been in decline for several years, and this has not been sufficient to allow consumer spending to grow at a faster pace than GDP – due to relatively weak growth in household disposable income (HDI).
Between the March quarter 2011 and the June quarter 2014, for example, the household saving rate fell from 11.6% to 9.4% of HDI, yet real consumer spending only grew at an annualised pace of 2.3% – compared with 3.2% growth in real GDP. That was because real[1] HDI over this period only grew at an annualised rate of 1.5%.
It’s hard to see real HDI growing faster than GDP anytime soon. Importantly, the weakening $A is now acting to increase consumer prices which will crimp growth in real incomes. Today’s relatively high unemployment rate and very slow growth in nominal wages will also limit income growth. What’s really needed to boost household income is a decent rebound in employment growth, though so far at least (and notwithstanding last month’s “catch-up” surge in reported employment), hiring indicators still remain relatively subdued.
Accordingly, even though the household saving rate may well decline further in the coming year – meaning households will spend more of what they earn – weak income growth could still cause consumer spending to grow at a slower pace than GDP. If so, it will add to upward pressure on the unemployment rate, and downward pressure on both interest rates and the A$.
For more of David Bassanese's Market Insights, go to the BetaShares blog. For more information on BetaShares funds, go to the main BetaShares website.
Frequently Asked Questions about this Article…
Consumer spending is crucial as it accounts for 53% of the economy's real GDP. The choices households make about spending or saving significantly influence the economic outlook.
The 'wealth effect' refers to the tendency of households to spend more as their wealth increases, often leading to a lower saving ratio. This effect is seen when rising house and share prices boost household wealth, encouraging more spending.
Weak income growth poses a downside risk to consumer spending because even if household wealth increases, limited income growth can restrict the ability of households to spend more, potentially slowing economic growth.
The household saving rate has been declining for several years. For instance, it fell from 11.6% to 9.4% of household disposable income between March 2011 and June 2014, yet consumer spending did not grow as fast as GDP due to weak income growth.
Household income growth is being limited by a high unemployment rate, slow growth in nominal wages, and a weakening Australian dollar, which increases consumer prices and reduces real income growth.
A significant rebound in employment growth is needed to boost household income. Although there was a recent surge in reported employment, hiring indicators remain subdued, indicating that more consistent job growth is necessary.
If weak income growth continues, it could lead to consumer spending growing at a slower pace than GDP, which may increase unemployment and put downward pressure on interest rates and the Australian dollar.
For more of David Bassanese's Market Insights, you can visit the BetaShares blog. Additionally, for information on BetaShares funds, you can go to the main BetaShares website.