Peeling away the layers of this week's strong GDP result reveals a disappointingly soft picture for the Australian household sector. The 1.1 per cent quarterly gain lifted growth nationally to a robust 3.5 per cent annually in the first quarter but was dominated by a surge in resource exports with domestic demand still weak. The transition from mining to non-mining led growth is continuing but looking somewhat shakier as consumer spending remains restrained and a hit to confidence comes through. Indeed, next week's Westpac-MI Consumer Sentiment survey looms as a critical update that will set the tone for the consumer sector through the remainder of 2014.
Firming consumer demand is key to ensuring a smooth transition from mining to non-mining led growth. There are really several separate parts to this transition. The first involves the most interest rate sensitive sectors picking up, i.e. housing. The second involves some added momentum in consumer demand, initially in response to lower interest rates but then as we start to see positive spillovers from the housing upturn. The third, and most tenuous, part of the transition is around non-mining business investment which rises in response to stronger growth in sales and rising capacity utilisation. This is where momentum broadens and strengthens, generating the positive feedbacks via employment and household incomes that give the upturn more convincing momentum, particularly as the drag from the mining investment downturn diminishes.
So far, the first part of the transition is firmly in place. The housing sector surged strongly in 2013 and although we have seen some signs of cooling off in 2014 – most notably in buyer sentiment – this is unlikely to drive a sharp reversal. The lift in construction in particular is set to run through 2014 and well into 2015 with recent declines in dwelling approvals (from very high levels) only having an impact from around mid next year.
The first quarter national accounts suggests the second part of the transition is progressing much more unevenly. While a strong rise in dwelling investment was enough to offset falling business investment in the quarter, consumer spending was disappointingly soft. Total consumption rose just 0.5 per centqtr well below our expectations of a robust 0.8 per cent gain. After showing a promising firming through 2013 – up 0.7 per cent, 0.7 per cent and 0.8 per cent in the second, third and fourth quarters, respectively – spending appears to have lapsed back to the lacklustre growth rates that featured through much of 2011 and 2012.
That said, there are enough 'wrinkles' in the data to suggest some of the softness may be overstated. Although it is broadly consistent with the weakening in consumer sentiment the timing looks a little out – gradual sentiment shifts such as those seen early in the year tend to impact spending with a bit more of a lag.
The quarterly spending number also looks out of step with surveyed retail sales and private sector business surveys which showed strength continuing through most of the quarter and only softening more recently in March-April. Adding to the puzzle, quarterly retail sales volumes showed little direct translation to the retail components of the national accounts measure: our retail 'proxy' from the accounts posted a lacklustre 0.4 per cent gain vs the 1.2 per cent rise for the quarter in the retail survey with notable undershoots on food, clothing & footwear and furnishings & household equipment.
There are some valid reasons why we might see a gap between the retail survey and the national accounts. In particular, we have seen similar wedges in the past when there have been big swings in tourism flows and/or exchange rates. The national accounts estimate includes spending by Australians abroad and excludes domestic spending by foreigners in Australia. Normally this is a trivial aspect of the estimates but it can sometimes have a big influence on specific quarters. There are some indications from balance of payments and arrivals/departures data that this may have been a factor in the first quarter – tourist departures for example fell 1 per cent in the quarter but bounced back sharply in April.
The timing of Easter in 2014 and its proximity to the ANZAC Day public holiday, the vagaries of seasonal adjusting for these effects and, going into May, the potential impact of abnormally warm weather conditions add further layers of complexity in assessing the monthly data. The Easter timing effect for example appears to have had a hand in the monthly tourism flows mentioned above and in an outsized 2.5 per cent fall in hours worked reported in the April labour force survey. It may also have embellished the April retail sales figures slightly, although the ABS attempts to adjust for this effect. Perhaps the strongest evidence of an effect is from new vehicle sales, with industry data pointing to a seasonally adjusted drop in consumer sales of over 4 per cent in April, reversed with a 5.7 per cent jump in May.
Setting these technical issues to one side, the broader picture around consumer demand is still of a clear softening since the start of the year. The quarterly spending estimates may be revised up a touch in time or partially reversed in the next quarter but the overall picture is likely to remain broadly similar.
Perhaps the most significant aspect of the first quarter household sector detail is the picture around income and savings behaviour. Real household disposable incomes are still coming under considerable pressure, rising just 0.6 per cent for the quarter and 1.4 per cent for the year. That's well below long run average growth of 3.4 per centyr. Moreover it’s been weak for a long time now: growth has been sub-2 per cent since 2011. While real incomes may not have registered the sort of outright falls we see during a recession, this is the longest stretch of sub-2 per cent growth on records back to 1960.
Meanwhile households are maintaining a high level of savings. The household savings ratio essentially held steady at 9.7 per cent in the first quarter. Despite some indications of easing risk aversion over the last year, consumers are still clearly prioritising saving over spending even with incomes under pressure. Pre-GFC, it was common to see savings rates decline when income growth slowed, with households reducing savings and drawing on reserves to maintain spending. That is clearly not the pattern post GFC.
Another way of looking at this is that, as at March, there were no indications of a significant 'wealth effect' on spending. Household net worth rose by $700 billion in 2013, driven by the surge in house prices. Some, including the RBA, had expected this to give a modest uplift to spending over and above incomes – a shift that would result in a lower household savings ratio. The absence of this shift to date supports Westpac's view that this effect would be negligible at best. To date it has been non-existent.
We will get a better sense of where consumers are at with next week's Westpac-MI Consumer Sentiment survey. Our last survey in May was heavily impacted by a sharp negative reaction to the budget which saw the headline Index slump from 99.7 (about neutral) to 92.9 (significantly downbeat). The June update will give some indication of how much of this may have been an over-reaction. The signs going into the survey are not great, with polls showing the budget fallout is still weighing on peoples' minds in early June. History also suggests sentiment does not snap back immediately from budget-related falls.
The June survey will also give important reads on consumer attitudes towards risk, via additional questions on the 'wisest place for savings', and insights into the factors influencing sentiment, through responses on news recall (both question are run every third month). We will also get updates on our regular monthly measures of unemployment and house price expectations, and consumers' assessments of whether now is a good 'time to buy a dwelling' – all of which appeared to be less affected by budget negativity in May but have shown a material weakening since the start of the year.
Overall, there is already enough evidence to suggest the softening in consumer demand since the start of the year will extend through mid 2014 and linger in the second half. We expect consumer spending to continue to eke out modest gains (0.5 per cent in the second quarter and 0.6 per cent in the third) before regaining momentum later in the year (0.8 per cent in the fourth quarter). An eventual recovery in sentiment and an easing in job loss fears will play key roles in overcoming this mid-2014 lull. If sentiment were to instead stay weak, that would be more problematic. It would raise the prospect of a more pronounced slowdown in consumer demand that could also threaten the critical 'third part' of Australia's growth transition in 2015 – an eventual pick up in non-mining investment. The Governor's statement accompanying this week's RBA decision studiously avoided any mention of the sharp post-budget fall in sentiment, but clearly the bank will be counting on some improvement in the months ahead.
Matthew Hassan is senior economist with Westpac.