Do we spend less when we feel poorer? Even when inflation and the cost of credit are low?
At a glance
- Interest rates in Australia are at an all-time low, and expected to fall further by the end of the year.
- Consumer confidence declined once again after the RBA’s June rate cut, prolonging a period of low consumer sentiment.
- Weaker economic growth is a contributing factor – Australia’s annual GDP growth rate is at less than 2 per cent.
- Australia’s household debt-to-income ratio has risen to 190 per cent from 70 per cent in the 1990s.
There was little applause in early June when Reserve Bank of Australia (RBA) governor Philip Lowe finally got to deliver the financial punch line that just about every economist in the country already knew was coming.
After 33 months of interest rate stagnation, Lowe announced that the central bank’s board had decided to cut the official cash rate by 0.25 per cent to 1.25 per cent.
Interest rates in Australia have never been this low, and there’s every likelihood they will go lower by year end.
“Our latest set of forecasts was prepared on the assumption that the cash rate would follow the path implied by market pricing, which was for the cash rate to be about 1 per cent by the end of the year,” Lowe told a Sydney business audience on the same day as his June rates announcement.
Such news would ordinarily have mortgage borrowers jumping for joy, and most lenders did move rapidly to drop their home loan rates shortly after the RBA’s decision – with strong prodding from Federal Treasurer Josh Frydenberg – although some failed to pass on the full cut.
Yet, in an economy where record-low rates have done little to stem the sharp fall in home prices, especially in Sydney and Melbourne, many consumers are feeling anything but exuberance these days.
Australia's mixed economic picture
Just a week after the June rate cut, the release of a Westpac-Melbourne Institute Index of Consumer Sentiment survey showed another slump in consumer confidence levels, with the decline reflecting poor expectations for the economy over the next 12 months.
On multiple levels, the Australian economy is showing strength. Employment growth remains steady across areas such as business services, construction, mining and health care.
Wages growth, although low for quite some time, is slowly beginning to trend higher, especially in the private sector.
Combine that with extremely low inflation and low interest rates, and the ingredients should be there for higher consumer confidence and spending.
Why are consumers so negative? Weaker economic growth isn’t helping, with Australia’s annual gross domestic product (GDP) rate at less than 2 per cent.
That’s reflected across most business sectors, with lower earnings results weakening conditions. No segment has been more affected than retail, where consumers are scaling back purchases of household goods, new vehicles and other discretionary items.
Ultimately, consumers are still feeling the pinch. Even though rates are so low, household debt levels are at a record high. RBA data shows the household debt-to-income ratio has risen from about 70 per cent at the beginning of the 1990s to about 190 per cent now.
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The wealth effect
AMP Capital chief economist Shane Oliver says that mortgagees will benefit from lower interest rates, which could allow them to pay down their debts faster.
“They’re the group that changes their spending the most based on overarching economic conditions, so I think the cut will provide a little bit of help for the wider economy,” Oliver says.
How much rate cuts contribute to fueling a turnaround in housing demand and boosting household spending levels is open to debate.
“Despite some recent positive developments, S&P Global Ratings expects house prices in Sydney and Melbourne to fall further in the next six to 12 months due to weak consumer and business sentiment,” says S&P analyst Sharad Jain.
“Low wage growth, global economic uncertainties, and a realisation by market participants that Australian house prices and private debt are high are among the factors posing a drag.”
In a speech to the Housing Industry Association in March, RBA assistant governor Luci Ellis drew a connection between house prices and household spending, but noted that the linkage was subtle.
“It isn’t so much that people wake up one morning, realise their home is worth more and decide to go out shopping,” she said. “Rather, if their home is worth more, they can borrow more against it, which matters for some people’s decisions to buy a car.
“Because rising housing prices usually occur in the context of high rates of transactions in the market, spending on home furnishings tends to rise and fall with housing prices.
So, when housing prices decline, turnover also declines.”
Ellis said that the RBA had been calling out the issue of weak income growth and how it might test the resilience of household consumption spending for years.
“I think it’s clear that conditions in the household sector more broadly are highly consequential for the housing sector,” she said.
“Whatever other forces might be affecting housing market developments, fundamentally, demand for housing rests on the household sector’s confidence and capacity to take on the financial commitments involved in the purchase or rental of a home.
“Without enough income, and so without a strong labour market, that confidence and capacity would be in doubt.”