Of all the components in Australia’s September quarter GDP report, none created as much concern as the weakness in household consumption, the largest part of the Australian economy at a shade under 60%.
It grew by a paltry 0.1% in the three months to September, the weakest quarterly result since the global financial crisis.
Making the soft result all the more surprising, it came despite solid growth in employment over the same period, and a lift in labour costs, with households choosing to save a little more, rather than spend, diverting from the trend seen in recent years.
To Bill Evans, Chief Economist at Westpac, the weakness in household consumption was a shock, raising questions as to whether a rebound in household spending will be able to help lift GDP growth to an above trend pace of 3% or more in the years ahead.
“The message from this report may be that households are accepting of a lower profile for income growth and are now adjusting to that outlook,” he says.
“Until the September quarter households were prepared to spend at a faster pace than income growth and running down the savings rate in the process. The savings rate had fallen from 7.2% in March 2015 to 3.0% in June 2017.”
Although one quarter does not make a trend, Evans says the tailwinds that allowed household consumption to grow at a faster pace than incomes over recent years will likely fade in 2018, potentially weighing on household spending.
“We expect that boost in hours worked will ease significantly in 2018 while there is little relief on the wages front. Nominal labour income growth is likely to ease in 2018 from around 4% in 2017 to 3.5% in 2018 maintaining downward pressure on consumption,” he says.
“We have lowered our through the year forecasts for consumption in 2018 from 2.5% to 2.3%, and maintained our 2019 number at the 2.5%.”
Despite the expected weakness in consumption, Evans has maintained his GDP growth forecasts for both 2018 and 2019 at 2.5%, acknowledging that soft household consumption will probably be offset by stronger government spending.
However, of the risks attached to this view, Evans says they’re “firmly to the downside”.
“The risks to our growth forecasts are firmly to the downside with only a modest further slip in our consumption profile seeing growth in 2018 slide to a disturbing 2.25%,” he says.
The annual GDP growth of just 2.25% is one full percentage point below the 3.25% level currently expected by the Reserve Bank of Australia.
Regardless of whether those downside risks eventuate in reality, Evans says the recent weakness in consumption points to the likelihood that the RBA and Australian Treasury will have to lower their expected GDP growth forecasts as a result.
“Those adjustments are going to make it very difficult for Treasury to maintain its 2018/19 growth forecast [of 3%], although boosting business investment and government spending will probably allow it to maintain that 2.75% in 2017/18,” says Evans.
“The [RBA] may also be reviewing its growth forecasts based on a more cautious consumer, particularly the 3.25% forecast for 2018/19.”
Of course, if GDP undershoots the RBA’s forecasts, it will almost certainly create downside risks for employment, wage and inflation growth, making it less likely that the bank will begin to lift official interest rates.
That’s exactly what Westpac expects, forecasting that the RBA cash rate will remain at 1.5% until at least 2020.