Australian household finances, already stretched by years of weak wage growth and high levels of indebtedness, are about to take another hit courtesy of a recent sharp increase in electricity prices at the start of July.
“Bill shock”, as it has become known, is about to arrive in your letter or inbox, creating additional headwinds for household spending and, as a consequence, the outlook for economic growth.
This chart from the Commonwealth Bank helps explain why this is an issue for the economy.
It shows the volume of gas and electricity consumed by Australian households overlaid against changes in energy prices over the past few decades. Combined, it shows the total amount spent by households on energy as a share of total spending.
In response to higher electricity and gas prices, households have reduced the amount of energy that they use. However, prices have risen at a far quicker pace over the same period, seeing the share of household spending directed to energy costs lift to around 2.5%.
While 2.5% doesn’t sound like much, Kristina Clifton, economist at the Commonwealth Bank, suggests this increase, coming at a time when household budgets are already stretched, could see Australians cut back their discretionary spending even further.
“Rising electricity prices are another headwind for households to face,” she says.
“The share of household spending on electricity and gas rose steadily between 2007 and 2014 and now sits at around 2.5%. The share rose because of a steep rise in electricity and gas prices over this time. As prices rose households responded by cutting the amount of electricity and gas used.
“However there is a limit to how much further households can reduce volumes. And it’s unlikely it will be enough to offset the latest jump in prices.
“In this sense higher electricity and gas prices are like a tax on households. And with household balance sheets stretched and wages growth weak, it will mean that many households will have to reduce spending on discretionary items.”
Not exactly an ideal scenario for what is the largest and most important part of the economy, nor the outlook for Australian retailers.
Clifton is not alone in warning that higher energy prices could put the breaks on discretionary spending.
Joanne Masters, senior economist at ANZ, is another who sees the recent hike in electricity prices as a threat.
“Given that electricity is largely a non-discretionary expense, any rise in electricity bills is likely to be matched by a reduction in discretionary spending, adding further pressure to already-struggling retailers,” she said in a note released in late July.
And history is on her side.
As seen in this chart from ANZ, household discretionary spending plunged following the introduction of Australia’s now-defunct carbon tax in mid-2012.
According to Masters, discretionary spending rose by 0.4% in the September quarter of 2012 before plunging by 1.8% in the next, coinciding with energy bills hitting the inboxes and letterboxes of Australian households at the start of the December quarter.
Bill shock hit, big-time.
While Masters says the hike in energy costs this year is lower than those seen in 2012, increasing the average cost for an Australian family by around $200 per annum in the current financial year based on her estimates, she says it still runs the risk of curbing spending levels in the coming quarters.
“They are likely to hit discretionary spending, which presents a challenge to the already struggling retail sector,” she says.
And not only does that present a threat to retailers, but also the great swathes of people who work in retail, second only to healthcare in terms of total number employed.
Any further job-shedding across the sector will run the risk of placing upward pressure on unemployment, making it harder to generate wage pressures and boost household spending levels.
While only speculation at this point, it’s clear that higher energy costs risk such a scenario playing out.