When it comes to determining the health of the Australian economy, nothing is more important than households.
At a smidgen under 60%, household consumption is the largest part of Australian GDP, meaning shifts in spending behaviour are felt across the broader economy.
Of late, things on that front haven’t been all that good.
According to the ABS, nominal retail sales, accounting for around 30% of consumption, fell by 0.3% in the September quarter, the equal-largest decline since the global financial crisis.
Prices fell by 0.3% over the quarter, the largest decrease in 13 years. And even with heavy discounting, sales volumes grew by a paltry 0.1%.
Despite booming employment growth, heavy discounting and annual population growth of 1.6%, it wasn’t enough to coerce households into lifting spending levels.
While this doesn’t take into consideration spending on services, the largest part of household consumption and for many, the most important part of the Australian economy, it was a unnerving result.
Even the Reserve Bank of Australia (RBA), regarded by many as eternal optimists, expressed concern about recent weakness in retail sales, noting it “was expected to translate into lower quarterly consumption growth than in the June quarter” in the minutes of its November policy meeting.
It added that the “outlook for consumption growth depended on the outlook for household income growth, which remained uncertain”.
While some argue the weakness may have been caused by households pushing back spending plans ahead of the arrival of Amazon in Australia, it’s not exactly been a good time for household budgets in recent months.
This clearly had an impact, as George Tharenou, economist at UBS, points out.
“A clear negative, particularly for retail sales, is that nominal household cash flow has slumped towards a record low of only 2% year-on-year in 2017,” he said in a note released today.
This chart from UBS shows the annual change in household cash flow overlaid against annual growth in nominal retail sales. There’s clearly a relationship between the two.
There’s two questions that therefore need to be asked.
The first, whether the weakness in retail sales was mirrored by spending on services during the September quarter. The second, whether the recent trend in retail sales is an aberration, or a sign of things to come.
On the former, Tharenou says the soft retail result is unlikely to be reflected in spending on services during the quarter, noting that the shift away from consumption of goods to experiences has been ongoing for some time now, falling from over 40% of consumption in the 1980s to just over 30% today.
So, on those grounds, Tharenou says there’s unlikely to be a ugly household consumption slowdown in Australia’s Q3 GDP report released in early December.
However, on the second question — whether the recent weakness in retail sales may be a sign of things to come for broader household consumption — he, like the RBA, says there’s now increased uncertainty as to whether the recent deceleration will reverse in the coming years.
Particularly with the housing market starting to slow.
“A fading household wealth effect will also likely slow the consumer ahead,” he says.
“We still expect house price growth to slow to 0-3% in 2018, rather than expecting a large fall in prices. But this could see households become less willing to rundown their savings rate at the current pace.”
Although Tharenou expects a modest acceleration in household cash flow growth, seen in the chart above, he says there’s now a growing risk that despite that improvement, household consumption growth will remain weak despite recent strength in hiring and booming population growth, currently running at 1.6% per annum.
“While the retail data probably overstates the extent of the slowdown, there is now downside risk to our consumption outlook. Indeed, recent annual GDP revisions suggest that consumption growth had already dropped to just 2.1% in 2016/17, the slowest pace since 2012/13.”
Tharenou is currently forecasting that real household consumption will grow 2.2% next year, well below the 3% level the RBA expects will arrive in the years ahead.
The downside risk to this forecast, he says, is uncertainty as to whether household income growth will improve as many, including the RBA, currently expect.
“The key to deliver a better consumer environment is average earnings needs to rise. Otherwise, while the economy has lots of people and jobs growth, consumers have little purchasing power, which keeps consumption and CPI low,” he says.
On that front, he says that’s now looking increasingly uncertain.
On top of Australia’s incredibly weak September quarter Wage Price Index (WPI) released earlier this month, a result that pointed to underlying wage growth falling to the lowest level on record, Tharenou points to recent enterprise bargaining agreements (EBAs) as another downside risk to employee earnings.
“We are seeing some stabilisation, and look for some modest recovery ahead, given booming jobs growth and a trough in wages,” he says.
“That said, we now feel less convinced of this view given the recent collapse in EBA’s suggest underlying wage pressures remain weak.”
Should underlying wage pressures continue to undershoot, a phenomenon that has recently become the norm rather than the exception in not only Australia but other major developed economies, Tharenou says there’s now a growing risk the RBA will have no choice but to keep interest rates steady.
“For the RBA outlook, our analysis suggests downside risk to the consumer outlook, which keeps inflation pressure low,” he says.
“If that occurs, the RBA could stay on hold for longer than our long-held view for the first rate hike to occur in [the December quarter of] 2018.”
In a speech delivered earlier this week, RBA governor Philip Lowe said that “a continuation of accommodative monetary policy is appropriate,” adding that “continuing spare capacity in the economy and the subdued outlook for inflation mean that there is not a strong case for a near-term adjustment in monetary policy”.
While he again repeated that it was “more likely that the next move in interest rates will be up, rather than down,” he made no attempt to alter market pricing which does not have a 25 basis point rate hike fully priced until well into 2019.
Perhaps he, like Tharenou, is now less certain that wage, inflation and GDP growth will accelerate to the same degree thought only a few months ago.