A looming revival in household incomes might not be enough to save Australian retailers

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It may be only early days, but the outlook for Australia’s households appears to be brightening.

Improved profitability at businesses, driven by strong operating conditions and previous strength in commodity prices, appears now to be slowly filtering down to workers.

Employment growth is accelerating, mirroring improvements in other labour market indicators and unemployment is tumbling, falling last month to the lowest level since February 2013, according to data released by the ABS.

Generally, wage growth tends to follow next.

However.

Labour market conditions in other developed nations are far tighter than in Australia right now and, to date, there have been few signs of a strong lift in wage pressures.

Even excluding that uncertainty, it’s the kind of outlook that bodes well for household incomes, and as a consequence, spending levels across the country.

Paul Bloxham, chief Australia and New Zealand economist at HSBC, shares that view, suggesting both wage and spending growth will likely rebound modestly in the coming quarters following a prolonged period of weakness.

“In our view, much of this weakness has been a result of the end of the mining boom. On this, things are turning around,” he wrote in a note released earlier this week.

“Typically, stronger profits eventually lead to faster wage growth. The bargaining power of workers may also be improving, with the unemployment rate recently falling to 5.5%, the lowest since 2013.

“We expect wages growth to edge higher in the second half of 2017, which should help support household consumption growth.”

There are already signs that is happening with the latest Business Sales Indicator (BSI) from the Commonwealth Bank, a measure of spending on both goods and services within the Australian economy, accelerating sharply in May, leaving nominal spending levels up 8.5% on the levels of a year earlier.

Bloxham, as opposed to others who have expressed doubts over the ability for household consumption to lift given a likely slowdown in Australia’s housing market, expects that rebound in spending to happen as soon as the second half of this year, picking up from 2.3% in the most recent national accounts to 2.6% over the entirety of 2017.

Beyond that, he suggests it will strengthen even further, accelerating again to 3% in 2018.

Source: HSBC

It sounds like a scenario that would have retailers licking their lips, excited by the prospect of increased household spending after years of consumer restraint and fierce competition, seeing margins and profitability erode sharply.

However, while Bloxham is predicting that household consumption will lift, he thinks that will largely be concentrated in spending on services, rather than retail goods, continuing the pattern seen over the past decade or more.

“As well as growing their spending more slowly, there has also been a structural shift in what Australian households buy,” he says.

“Back in 1990, household consumption was evenly split between good and services, whereas now, goods only account for around 22% of the volume of household consumption.”

And while as a proportion of consumption retail goods has been falling, he says that spending on services such as health, education, entertainment and restaurants and cafes has been moving higher, a trend that is likely to continue.

“This shift partly reflects that services are a superior ‘good’, meaning that as incomes rise households choose to spend more on these items,” he says.

Source: HSBC

Bloxham says technology has also played a part in this shift as consumers increasingly downloading music, movies, books, and news from online platforms, rather than buying records, videos, and newspapers from retailers as they did in the past.

It’s hard to see that shift from retail to online ending anytime soon. Indeed, it’s only likely to gather pace.

And with retailers battling for an increasingly small piece of the household spending pie, coupled with increased competition from online and foreign retailers, Bloxham thinks margins will continue to be squeezed, an outcome that will likely weigh on the share prices of Australian-listed retailers.

“Given global surplus capacity and increased competition from on-line players and new international entrants, we expect continued downward pressure to weigh on retail margins,” he says.

He’s not alone with that assessment.

In a note released earlier this year, Jo Masters, senior economist at ANZ, said that “retailers pricing power is being constrained by both the rise of online shopping, and the trend by major global retailers to enter the Australian market with brick and mortar stores.”

She too acknowledged the shift in consumer behaviour away from spending on goods to services, admitting that as a result of these two factors the pressures facing retailers will remain intense.

“These pressures may not intensify but are equally unlikely to dissipate any time soon,” she said.

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