Miserable consumers are the big issue for 2024 and probably 2025

The parlous state of the Australian economy is largely the function of consumers and the household sector, writes Stephen Koukoulas.

EVERYWHERE ONE LOOKS at news and updated data on consumers, the news is bad, poor or downright miserable.

Given that household spending makes up more than 50% of the gross domestic product, protracted weakness in consumer spending undermines bottom-line economic growth and with that, the level of employment, wage increases and the overall well-being of the economy.

The most recent data on the Westpac-Melbourne Institute index of consumer sentiment has been in the “pessimistic” zone for two years, hovering some 15 to 20% below a level that is considered neutral.

This is the longest period in the near 50-year history of the series that consumer sentiment has been entrenched at such a low level, including during the early 1980s and early 1990s recessions. Cost of living pressures and one of the most aggressive interest rate hiking cycles on record from the Reserve Bank of Australia (RBA) are crunching sentiment.

Wage growth outpacing inflation — good news to ease cost of living

Wage growth is increasing at a rate above that of inflation, which is good news for Australian citizens and also the Albanese Government.

Australian consumers are alert and knowledgeable. When their finances are under pressure, they respond quickly and decisively by trimming their spending.

This protracted period of weakness in consumer sentiment has, unsurprisingly, fed into an extended period of weakness in household spending.

Household consumption expenditure has, in real terms, registered almost no growth since the end of 2022 — the last four quarters have registered growth of 0.1%, minus 0.2%, 0.1% and 0.1%. These poor indicators of household spending are even more problematic when account is taken of the substantial population growth over that time — per capita, household consumption is down around 2.5% over the past year and down close to 6% from the peak two years ago.

This is the sort of spending momentum usually associated with a recession, with the weakness all the more concerning given the slump in the household saving ratio — a sign that consumers are paring back their contribution to savings to maintain basic spending on essentials.

Problems for consumers are also showing in retail sales data which have shown zero net growth over the past 18 months, again despite population growth and the effect on prices from the level of inflation.

What to do about it?

The near-term outlook remains grim but there are some grounds to think that consumers will be in a better shape later this year.

The Federal Government is doing the right thing to address the problem with its income tax cuts which take effect on 1 July 2024. Unlike the previous Coalition Government’s tax policy, the Albanese Government tax cuts are skewed towards middle and low-income earners, which is the section of the community that will benefit most and that will be more likely to ramp up their spending than high-income earners.

Cost of living hardest for those on income support

The cost of living crisis is really biting in Australia, so much so that the Government has called ministers to Canberra to discuss the issue before Parliament sits this year.

That said, all income taxpayers, even high-income earners, will benefit from the tax cuts.

Pressure is also building against the RBA to use the evidence of falling inflation, weakness in the economy and the lift in the unemployment rate to ease monetary policy — to cut interest rates, in other words. To date, it has downplayed the evidence of economic weakness and held the official cash rate at an 11-year high of 4.35%.

Even investors in the money markets are reassessing the interest rate outlook. In the past few weeks, despite the grim news on the Australian economy, market expectations for RBA interest rate cuts have been scaled back, driven more by data in the U.S. than locally. This can change and it remains likely it will change as more news of weak consumer spending and the economy comes through.

That said, the longer the RBA waits or, indeed, is blind-sided by events in the U.S. and postpones any decision to cut rates, the weaker consumer spending will be and the greater the rise in the unemployment rate will be through 2024 and into 2025.

Interest rates need to be cut.

Consumers are being crunched by current interest rate settings. In addition to the impact on cash flows and, therefore, spending, there is tentative evidence building that mortgage loan arrears and bad debts are starting to rise, albeit from a low base. And these data pre-date the full effect of the interest rate hikes, including the most recent 25 basis point rise in November 2023.

For now, consumers are under extreme financial stress.

Pro-growth policies can alleviate these problems. The Government is doing its part and it is now up to the RBA to step in soon and support economic growth.

Stephen Koukoulas is an IA columnist and one of Australia’s leading economic visionaries, past Chief Economist of Citibank and Senior Economic Advisor to the Prime Minister.