Consumer spending could help offset debt risks

The Commonwealth Bank of Australia’s chief economist, Michael Blythe, has said that while high levels of household debt, especially at a time of subdued income growth, is a risk to economic activity, consumer spending is a “source of stability” and “one of the least variable components of GDP growth”.

The chief economist added that the decline in the household savings rate — which is down to just 1 per cent of disposable income — has allowed consumer spending to “defy” the poor income growth.

A recent analysis of the transactions of 2.5 million households by the Commonwealth Bank has found that spending shares have remained “relatively constant” over the last few years, with a slightly larger share of spending going towards food (22.7 per cent), which Mr Blythe said “underlies the relatively comfortable position” households find themselves in.

The second and third biggest spending category for households is recreation and transport, with 17.2 per cent and 10.9 per cent of wealth being spent on these, respectively.

CBA’s latest Household Satisfaction Index (HSI), released in October, showed that the average household, which has 2.4 people, generates $90,000 in annual income and spends around $57,000 per year excluding rent and mortgage payments.

Housing accounts for 74 per cent of wealth (based on deposits, housing and equities), with the average household holding $274,000 in assets and $103,000 worth of debt on the liabilities side of the balance sheet, according to the major bank’s HSI.

“Higher borrowing means that the household [debt-to-income] ratio has lifted. But rising house prices means that the ratio of household [assets to liabilities] is also higher,” CBA’s HSI report stated.

The bank noted that rising household debt means households are increasingly sensitive to interest rate changes. A long line of banks had raised their interest rates in recent months, attributing their decisions to rising wholesale funding costs, despite the Reserve Bank of Australia keeping its official cash rate at the record low of 1.5 per cent for more than two years.

This presents a risk to consumer spending, according to CBA, along with the negative “wealth effect” from falling house prices.

CoreLogic’s Hedonic Home Value Index had reported a 2.7 per cent annual dip in national dwelling values in September, largely driven by a 6.1 per cent year-on-year decline in Sydney and a 3.4 per cent decline in Melbourne.

Recent findings from Roy Morgan’s Single Source Survey of approximately 10,000 owner-occupied mortgage holders had revealed that 8.9 per cent of borrowers (which roughly equate to 386,000 Australians) have been identified as having little or no real equity in their home, up from 8 per cent 12 months prior.

Consumer spending could also be impacted by the rollover of interest-only (IO) loans into principal and interest (P&I), which the Reserve Bank warned earlier this year might require borrowers to pay an extra 30 per cent to 40 per cent in annual mortgage repayments (or an additional “non-trivial” sum of $7,000 a year) upon contract expiry. The central bank noted that the increase would make up 7 per cent, or $120 billion, of the total housing credit outstanding.

Commonwealth Bank said that these observations “underline the critical importance of getting the economic and policy backdrop right” as well as why the Liberal government’s personal income tax cuts “should be welcomed”.

“The correct environment will see jobs growth continue, labour market slack diminish and wages eventually respond. Tax cuts, while small, will help at the margin. But more action would help,” CBA’s HSI report stated.

“The tax cut agenda could be brought forward. And we have argued for some time now that we should be thinking about wages policy as well as the more traditional monetary and fiscal policies.”

The major bank’s report cited findings from a survey by the Organisation for Economic Co-operation and Development (OECD), which showed that the issues most important to Australians are work/life balance (12 per cent), health status (10 per cent), housing conditions (9 per cent), education and skills (9 per cent), subjective wellbeing (9 per cent), personal security (9 per cent), income and wealth (8 per cent), jobs and earning (8 per cent), and environmental quality (8 per cent).

“Men tend to give a higher weight to income. Women see community ties and work/life balance as more important,” CBA’s HSI report stated.

“Older respondents value health, safety, housing and civic engagement relatively more highly. Younger respondents value life satisfaction, work/life balance, jobs and incomes more highly.”

An analysis by Morgan Stanley of the world’s 10 leading developed economies had recently concluded that Australia’s economy is most at risk from household debt reduction due to weakening house prices and the possible introduction of further macro-prudential or tax changes, such as potential limits on negative gearing to new housing and the halving of the capital gains tax concession, as proposed by the Labor Party.

Australian households could face a collective $700 billion cut to their wealth, according to Morgan Stanley’s estimates, which could in turn drag consumption down by 1 per cent to 4 per cent in the next two or so years.

[Related: Household wealth could plummet by $700bn]