Australian retail sales beat expectations with a 0.4% print this morning.
That’s a good thing for the economy, but continued spending by Australian households is also a necessary requirement for the federal budget forecasts to hit their mark.
That’s because the Budget, deficit, and Australia’s economic growth rate this year, and in years ahead, all rest on the accuracy of the Treasury’s forecasts.
And one of the Budget’s more important forecasts is the rate of household consumption, which is predicted to grow at a 3% annual clip over the next three financial years.
That’s not exactly an heroic assumption given household consumption expenditure was the primary driver of economic growth in the fourth quarter of 2015. The data showed consumption up 0.8%, taking the annual growth rate for this sector of the economy to 2.9%. Growth in household spending contributed 0.4% of the Q4 growth rate of 0.6%.
The 2.9% figure is close enough to 3% to call it even, but can household consumption growth continue at that rate?
That’s a reasonable question given that, in no small measure, the decision by households to lower their savings rate contributed to that level of increased consumption, and economic growth at the end of 2015.
There is little doubt the RBA would have been pleased with that fall in the savings rate and increase in household consumption. That’s because this is a big part of how the RBA expects lower interest rates to help transmit stimulus, allowing the current transition to deepen and spread throughout the domestic economy.
So both the treasurer and RBA would be happy to see the household savings rate fall to a new post-GFC low of 7.6% at the end of 2015. It supports Australian growth.
But both the Budget papers expect – and the treasurer reiterated yesterday in his Press Club speech – that the savings rate will continue to fall and thus drive consumption growth.
Budget paper No. 1, section 2 says:
Household consumption is growing steadily, underpinned by strong employment growth, a fall in petrol prices of around 15 per cent over the past year, and a declining household saving rate. A buoyant housing market has also been supporting consumption through rising household wealth, as well as through expenditure on housing-related items such as furnishings.
The Budget also forecasts household consumption to grow at a 3% annual rate “each year across the forecast period”.
But is it reasonable to expect Australians to continue to drive down their savings rate in favour of consumption in the current economic environment of low inflation and low wages growth?
The treasurer believes so given the budget papers, and forecasts, say “the household saving rate is expected to decline further at a moderate pace, but remain well above pre-crisis lows”.
Yet the papers add the caveat that “uncertainty around the pace of decline in the household saving rate poses a risk to the rate of consumption growth”.
It’s this uncertainty that could prove to be both the budget’s and domestic economy’s Achilles heel.
We asked Paul Dales, Capital Economics chief economist for Australia and New Zealand, about the outlook for savings and consumption.
Dales said “the saving rate is usually determined by net wealth. If the value of household wealth is being boosted by rising equity/house prices, then people can afford to save less and vice versa. There was a big step change in this relationship during the GFC, which means that households want to hold more savings for any given level of wealth”.
That’s not entirely the disagreement with the treasurer it sounds like.
That’s because while Dales isn’t forecasting a 3% growth rate for household consumption – he’s expecting 2.5% this year and 2.3% next – he did say that “there is scope for the saving rate to fall further. That means real consumption can continue to grow at a faster rate than real incomes for a while yet”.
It’s still sounds like a stretch to expect Australian household spending to grow at a 3% rate in the current environment. That poses a risk to budget forecasts and economic growth.
What it also does is bias RBA interest rates and the Aussie dollar lower in order to try achieve this result.