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Is the fall in consumer confidence overstated?
After six weeks of conflict in the Middle East, we are only now starting to receive official data on how the economy is responding. For Australia, data showed the unemployment rate was unchanged at 4.3% in March, but with the labour force survey taken early in the month, the data largely pre-dated any war impacts. Survey measures of consumer and business confidence, also released this week, made for sombre reading, with both falling precipitously. But is the outlook really as bad as confidence measures suggest?
Previous Weekly Economic Briefs have articulated our scenarios on the conflict in the Middle East. We have shifted our baseline economic forecasts to be in line with the benign scenario. A key feature of our benign scenario is that the spike in oil prices is temporary in line with a reopening of the Strait of Hormuz, sometime within the coming 6 weeks. While economic growth is expected to slow in this scenario, the economy is far from recessionary. The reopening of the Strait should bring about a recovery in consumer confidence.
Nonetheless, consumer confidence did paint a pessimistic picture for households, falling by 12.5% in April, plumbing the depths of the global financial crisis, the Covid outbreak and the recent cost-of-living crisis of 2022-23. But consumer confidence can be volatile and often gives a misleading guide on the outlook for consumer spending.
More important than results of consumer polls, which tend to overshoot on the downside (and also the upside), is understanding the underlying drivers of spending growth, like incomes. While real disposable income growth will slow this year, consumer fundamentals are very different now compared to the cost-of-living crisis of 2022-23.
During the cost-of-living crisis of 2022-23, household real disposable income fell by 3% as inflation surged to almost 8%, the cash rate was raised by over 4 percentage points and bracket creep pushed up the income tax take. In contrast, this year we expect inflation to peak around 5%, the cash rate to increase by less than 1 percentage point and for modest income tax cuts to offset bracket creep and household real disposable income growth to slow, but to remain positive.
Slower growth in real disposable incomes does put pressure on households to reduce spending. But consumers tend to smooth their spending patterns over time, with households typically choosing to run down savings in response to temporary falls in income. And unlike 2022-23, when the savings rate fell to just 2%, households can afford to run down savings having rebuilt the savings rate to around 7%.
There is no doubt that the size and speed of the increase in fuel prices, which caught many households off-guard, contributed to the fall in consumer confidence. Fuel is essential to the daily needs for many people and so the price spike puts pressure on household budgets.
The Westpac-DataX card tracker, that aggregates card transactions for Bank customers, shows a full percentage point of total spending on fuel in March. Regional customers were harder hit than those in capital cities. In April, the temporary halving of the fuel excise tax has provided some relief to household budgets. As the Strait of Hormuz opens later in the year, falling oil prices will lower petrol prices, contributing to a recovery in consumer confidence.
Apart from petrol, other essentials like food, will see price rises as farmers face increased costs for diesel, freight transport and fertiliser. Higher farmgate costs will be passed on to consumers as higher grocery prices.
Although we expect consumer spending to hold up in aggregate, the higher cost of essentials will be partly accommodated by a reduction in spending on non-essential items. The obvious losers are those non-essential items whose prices are most sensitive to the fuel price shock. For example, the Westpac data show that spending on overseas travel took a hit in March, while domestic travel and holiday accommodation has also been curtailed.
The pessimistic headlines around confidence are not unexpected given the size and speed of the fuel price shock. But initial reactions are usually exaggerated, and this has often been the case with consumer confidence. Compared to the cost-of-living crisis of 2022-23, economic and consumer fundamentals are more balanced, meaning that households are better placed to weather the current shock. However, if the Strait of Hormuz remains closed into the second half of the year, the resilience of consumer spending will be challenged.