Ability and willingness to spend: How well or poorly the Australian economy grows over the next year will depend upon the relative strength of household spending. Of course there are other contributions to growth in expenditure-based GDP – government consumption and capital spending, business capital spending and exports – but these all seem set on growth paths that net out to near zero growth in aggregate. Concern about potential sovereign credit rating downgrading is likely to keep the government obsessed with reducing budget deficits and growth in government spending in aggregate modest at best. The downturn in business investment spending led by the mining sector is unlikely to bottom out for at least a year. Export volumes are increasing but at no faster pace than over the past year, possibly even a little slower with only moderate improvement in China’s demand for Australia’s bulk commodities. The swing factor in the outlook for spending rests with the household sector. Reliance on a falling savings ratio......
Through much of 2015 to the latest GDP reading for Q1 2016, household spending has been holding up well, notwithstanding potential headwinds from persistently slow growth in wages and a record high household debt burden. Household consumption expenditure rose in Q1 2016 by 3.0% y-o-y in real terms, while spending on housing rose by 7.0% y-o-y. This strong real growth in household spending occurred against a backdrop of very weak wages growth, only 2.1% y-o-y in nominal terms according to the Q1 2016 wage price index, although compensation of employees according to the national accounts was not quite as weak (3.6% y-o-y in Q1, nominal). On either measure of wages growth Australian households had to save relatively less of their regular income (borrow more) to fund such strong spending growth in Q1 2016 (vs Q1 2015). This showed through in the household savings ratio (savings as a proportion of household disposable income) falling from 8.6% in Q1 2015 to 8.1% in Q1 2016.
Will households change their savings behaviour?
In effect, Australian households overcame the constraint on their ability to spend more sourced from weak income growth by their willingness to save less and borrow more. A key question is whether these dynamics influencing the ability and willingness of households to spend are showing signs of changing?
In terms of wages growth there are no signs that very low wages growth will change over the next year. Enterprises in both the public and private sectors continue to look for ways to contain or reduce costs, including labour costs by reducing paid hours worked. The story of employment growth so far in 2016 has been one of what limited growth there has been (only 35,000 additional jobs in the first five months) has been entirely part-time positions. Indeed, full-time employment has fallen by more than 39,000 positions so far in 2016.
Softer employment impacts wages growth
There are two implications for wages growth which follow from this softening in employment growth.
The first is that Q2 2016 wages growth as measured by the wage price index may have edged down below the 2.1% y-o-y recorded in Q1.
The second implication is that compensation of employees in the Q2 national accounts will likely be materially less than the 3.6% y-o-y reported in Q1.
The constraint on households’ ability to spend from weak wages growth appears to have become more pronounced in Q2 and with little hope of any relief looking further out in Q3 and Q4 2016. If households were to keep growing their spending at the relatively fast annual pace recorded in Q1 they would have needed to run down their savings ratio even faster.
Will cash rate cuts benefit household spending?
One spur to running down savings and spending more occurred during Q2 when the RBA reduced the cash rate by 25 bps to 1.75% with rapid flow through to bank mortgage lending rates. Of course, interest rate cuts are something of a two-edged sword in their impact on the household sector. The net-borrowing part of the household sector benefits but the incomes of the net-saving, mostly the older part of the household sector are further constrained. However, very high and still growing household debt outstanding shows the prevalence of net borrowers over net savers so on balance lower interest rates still have the potential to spur spending.
Evidence households are spending less so far in 2016…
Yet there is some evidence that household spending growth in Q2 2016 was not as robust as it was in Q1. Monthly retail sales growth was relatively soft in both April (+0.1% m-o-m) and May (+0.2%). There are also signs over recent months that spending on housing has become patchier – still strong in much of Sydney and parts of Melbourne but stalling just about everywhere else.
The story in Q2 seems to be one of households experiencing less ability to spend even though their willingness to spend has not yet been dented materially. Slowly diminishing annual growth in real household spending seems on the cards for Q2 and Q3. Whether that worsens beyond depends partly on whether employment and wages growth continues to lose momentum, but also on the impact of the policy response from the RBA and whether lower interest rates can lift the willingness to spend even as the ability to spend is increasingly constrained.
…a trend which will result in lower annual GDP growth for 2016
It is difficult to offer a confident forecast of how household spending will pan out in these circumstances. It appears that a softer trend in spending may have started. If this softer trend continues Australian annual GDP growth will be significantly lower by the end of 2016 than