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By Bob Cunneen, Senior Economist and Portfolio Specialist, NAB Asset Management
“You can add up the parts
You won't have the sum
You can strike up the march
There is no drum…..
There is a crack in everything
That's how the light gets in”
Leonard Cohen, Anthem
Australian consumers seem grumpy. The Westpac - Melbourne Institute Survey of Consumer Sentiment shows that consumers are pessimistic, as shown in Chart 1. Yet economists and policymakers are struggling to explain this angst and anxiety. There seems to be a “crack in everything” in terms of the nation’s consumer confidence … and still the Australian economy continues to grow.
Recent surveys and economic data show that Australian consumers have some good reasons for feeling cautious. There is the rapid rise in key essential prices, subdued income growth and high household debt. In short, consumers are feeling a big squeeze on their current living standards.
What exactly do we mean by “confidence"?
What we do know is confidence is a critical influence on the economy. Confidence can impact asset prices, share prices and economic growth for better or for worse. Consumer spending and business investment can be driven by confidence in terms of the willingness to spend, or a preference to save for a rainy day.
Economists have broadly referred to confidence as ‘animal spirits’ which covers a wide spectrum of behaviour and emotions including beliefs, perceptions and even the degree of trust. Confidence can also reflect recent events or expectations for the distant future. Hence confidence is considered “a restless and inconsistent element in the economy” where multiple emotional and rational factors interact. 1
While we may occasionally understand some factors that drive confidence results in consumer surveys, generally confidence is a major puzzle for economics. To paraphrase Winston Churchill, confidence is “a riddle, wrapped in a mystery, inside an enigma”.
Chart 1: Westpac - Melbourne Institute Survey of Consumer Sentiment
Source: Consumer sentiment was 96.6 in July 2017 compared to the 100 level where sentiment is neutral. Above 100 is positive sentiment where ‘optimists outnumber pessimists’. Below 100 is negative sentiment where there are more pessimists. Source: Westpac – Melbourne Institute Survey of Consumer Sentiment.
Chart 2: Australian consumer prices and wages over the past decade
Source: ABS, June 2017.
Electricity prices shock
There appears to be some key factors that are driving the current weak confidence results. Firstly Australian consumers are feeling the squeeze on their retail spending power given rising electricity and health costs. Chart 2 shows Australian electricity prices have essentially doubled in the past decade to June 2017, up an astonishing 8% per year. This financial year it’s expected to be 15%.
If you needed to consult a medical specialist after the shock of opening up your power bills, this would also cost a small fortune. Health costs which involve both hospital and medical expenses have been rising at a 4.7% annual growth rate since 2007.
Yet the broader Consumer Price Index (CPI) basket measure has Australia’s annual inflation rate averaging within the Reserve Bank’s (RBA) 2-3% target at 2.4% over the past decade. Notably clothing and communication prices such as mobile phones have fallen over the past decade.
But wages remain flat
Another contributing factor is that Australians aren’t seeing much increase in their wages. Chart 2 shows how Australian wages have only recorded modest 3.1% p.a. nominal growth since 2007 which is barely above the average 2.4% p.a. CPI inflation rate.
So adjusting for consumer prices, real wages have barely increased by 0.7% per annum for the past 10 years. This hardly constitutes rising living standards given the snail pace of real wage gains. The recent slowdown in nominal wage gains to only 1.9% annual growth in the June quarter 2017 is now in line with the CPI inflation rate. This effectively means living standards have been going sideways over the past year as inflation has matched wage gains.
House wins again…but debt rises
Clearly some Australian consumers are in a more fortunate position given the rise in wealth. Rising house prices have been particularly beneficial for owner- occupiers and investors. The Australian Bureau of Statistics measure of Australian residential property prices shows capital city prices have recorded average annual gains of 6% since 2007. However these are the fortunate few in terms of strong wealth accumulation that can help insulate against rising consumer prices and subdued income growth.
The other side of the household balance sheet shows that Australian consumers have binged on borrowing money. Chart 3 shows that household debt has surged to 190% of disposable income. So for every $1 of household income comprising wages and benefits, there is now $1.90 of household debt. Notably the RBA Governor Dr Phillip Lowe has warned that this “recent increase in household debt relative to our incomes has made the economy less resilient to future shocks".2 So concerns over high debt levels are likely to be weighing on consumer sentiment.
These concerns would have been magnified by the financial system regulator APRA announcing measures to tighten housing lending standards in March. These measures include new limits for housing interest-only loans and increased monitoring of loan valuation ratios given the “heightened risks”. This tightening of lending standards has also led to investor mortgage interest rates rising by 25 basis points since the start of 2017. 3
Chart 3 shows that while to March 2017 interest service ability was manageable at 8.6% of household income, the combination of rising debt and interest rate costs for housing investors since then will place a further squeeze on living standards.
Chart 3: Australian household debt vs interest payments
Source: ‘Statistical table E2: Household finances – selected ratios’, RBA, March 2017.
Given the rapid rises in the costs of electricity and health, subdued income growth and high household debt, Australian consumers are entitled to feel grumpy. These pressures can account for the recent subdued retail spending as well as the modest performance of the Australian share market compared to global shares in 2017. There’s a “crack in everything”’ in terms of current living standards, and a reluctance to let the “light get in” and become more positive. So confidence matters. However, like the weather, consumer sentiment does eventually turn for the better. When Australian consumers perceive that their real incomes are again rising and living expenses are manageable, then this grumpy sentiment should evaporate.
1 ‘Animal Spirits’, Akerlof GA and Shiller RJ, Princton University Press, 2009.
2 ‘Household debt, housing prices and resilience’, Reserve Bank of Australia Governor, Dr Philip Lowe, 4 May 2017.
3 Reserve Bank of Australia, August 2017.
Unless otherwise stated, all figures have been sourced from ABS, as at June 2017. The CPI Inflation data comes from the Australian Bureau of Statistics : Consumer Price Index 6401.
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