Money The pressure on Australian household budgets is real -- and there's no guarantee it'll improve anytime soon

19:48  14 february  2018
19:48  14 february  2018 Source:   Business Insider Australia

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The RBA thinks income growth will improve while warning “there is no guarantee of this”. The squeeze facing Australian household budgets is real — and there ’ s no guarantee things will improve anytime soon .

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  The pressure on Australian household budgets is real -- and there's no guarantee it'll improve anytime soon © AAP Image/Paul Braven The squeeze facing Australian household budgets is real -- and there's no guarantee things will improve anytime soon.

These aren't the opening remarks of the latest "Australia Recession 2018" report, but the view of Luci Ellis, Assistant Governor of the Reserve Bank of Australia (RBA).

In an excellent speech delivered to the ABE Conference in Sydney today, Ellis went beyond the usual discussion on why wage growth is so weak and chose instead to look at the broader risks to household consumption, the largest and most important part of the Australian economy.

It was an elaboration on the view in the minutes of the RBA's December monetary policy meeting, where it described household spending as a “significant risk” to the Australian economy.

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This government is fond of comparing the economy to a household budget - but there is one really major difference. The Australian Bureau of Statistics has changed what goes into its inflation calculation. AAP. Vital Signs: weak inflation means interest rates aren’t rising anytime soon .

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At the epicentre of the RBA's concerns, Ellis pointed out that something unusual is happening in the Australian economy right now with strong employment growth failing to translate to a pickup in household spending as seen in other advanced economies over the same period.

"Consumption growth in the major advanced economies has been quite robust, supported by strong growth in employment," she said.

"In Australia, we've also had especially strong employment growth over the past year -- more than double the rate of growth in the working-age population. But that hasn't translated into strong consumption growth."

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Pointing to the chart below, Ellis said the divergence is likely explained by weakness in household incomes which have grown at a far slower pace than consumption in recent years, leading many households to divert money away from savings to spending to make up for the income short-fall.

a close up of a map© Provided by Business Insider Inc "Consumption growth hasn't slowed as much as income growth," Ellis says, adding that "this is what you'd expect, given that households generally try to smooth their consumption through episodes of income volatility".

"But there's a real question of how long that could continue if income growth stays weak."

The answer, says Ellis, is not indefinitely, and much will depend on what happens to household income levels.

Either they'll improve, helping to underpin consumption, or they won't, creating a scenario where savings are all but eaten away leaving no other option but to cut spending levels.

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Then there are other factors, like the average per- household amount of credit card debt that stands “No matter how rich or poor you are, a budget is almost always a necessity because it can help you “Focus on buying appreciating assets like stocks and real estate, which would grow over time and

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"Continued weak income growth presents a particular risk to the consumption outlook in the context of high household indebtedness," Ellis says.

"Households do not just wake up one day and collectively decide to pay down their debt. But if incomes turn out weaker than they expect, or some other adverse news should arise, the households carrying the most debt might feel they have to rein in their spending quite a bit."

There's already some evidence that's occurring, with annual growth in spending in discretionary areas decelerating sharply, as seen in the chart below.

a close up of a map© Provided by Business Insider Inc While growth in discretionary spending is slowing, that's not yet been evident in spending on essentials.

This is a sign households may be cutting back on the little luxuries in life because of persistent weakness in incomes.

"The living cost pressures that many households feel have therefore been an income story, not a price inflation story," says Ellis.

"Although utilities prices did increase significantly in some states in recent quarters, much of households' regular spending has seen relatively little in the way of price increases for a number of years.

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"We might be seeing this in the details of the consumption figures... [with] growth in spending on discretionary items, like travel and eating out, has slowed while growth in spending on essentials has held up."

With households already saving less just to sustain spending levels, it means income growth will have to accelerate in order to prevent the significant risk surrounding household consumption deteriorating into a more damaging reality.

Otherwise the ad for the "Australia Recession 2018" report will almost certainly be on the money.

To Ellis, much like recent commentary from the RBA, recent labour market strength, along with better economic conditions both at home and abroad, should lead to an improvement in income flowing to households.

However, as she explains, there's plenty of uncertainty as to whether or not that will actually happen

"In Australia, wage growth has been quite weak even allowing for what we estimate to be the extent of spare capacity," she says, referring to amount of underutilised workers that still exist within the labour market.

"Our central forecast is that this weakness will end as the drag from the end of the [mining investment] boom dissipates and spare capacity is absorbed, such that average earnings growth recovers.

"There is no guarantee of this, though, and therein lies the risk."

If it wasn't already, it's clear that upcoming jobs and wage data has taken on significantly more importance, both in terms of the outlook for interest rates but also the broader Australian economy.

You can read the full speech from Ellis here. It's well worth your time.

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