Morgan Stanley: Consumer to hide stimulus under mattress

The nightmare is real, says MS, which lowered its Aussie growth outlook to 1.8% today:

The other driver of household spending weakness was the savings rate increasing …

In our view this reflects the pressures on household de-leveraging, in an environment of low wage growth, elevated debt and falling house prices.

This may also limit the effectiveness of stimulus coming over the next 12 months…some boost from fiscal and monetary stimulus in the second half of the year.

However, if this is used to delever rather that spend it is less likely to drive a substantial spending boost from the household sector.

House prices have fallen 14.9 per cent in Sydney and 11.1 per cent in Melbourne, but the rate of decline has slowed, which could ease the fall off in consumption.

Don’t forget that wages growth is also going to fade as unemployment rises while the immigration flood continues. The savings rate appears to have turned but certainly not fully:

Gerard Minack recently assessed these risks beautifully:

…the more significant support for growth has been the wealth effect: the willingness to reduce saving as house prices rise. Consumer spending has persistently out-paced income growth over the past few years as saving has fallen (Exhibit 2).

The simple point is that Australia may already have been flirting with recession if not for this saving decline. Nominal household disposable income growth is running at only 2% – near zero in real terms (Exhibit 3). If the saving rate had flat-lined, real consumer spending – accounting for 55% of GDP – would have shown no growth. (This assumes that the data are correct. Household saving is calculated as a residual: the gap between household income and spending. Also note that the expenditure measure of GDP increased by 6.3% last year, versus 4.8% for the income measure. It may be that income growth is being under-stated.)

The key factor behind the weakness in household income has been weak wage growth. Weak wage growth is easy to explain: wage growth is soft because underemployment is high (Exhibit 4). The underemployment rate – as well as the headline unemployment rate – is now rising on a trend basis, which is the key to upcoming RBA rate cut(s).

Although wage growth has been anaemic, total labour payments have risen due to rising hours worked. But the modest growth in aggregate labour pay has been largely offset by a rising effective tax rate on household income (Exhibit 5). Upcoming tax rebates will partly reverse these tax increases.

The income tax rebate, plus a presumed two 25 basis point rate cuts, would lift disposable income by ¾-1% in the second half of this year. This is nice to have, but needs to be set against the potential impact of adverse wealth effects. Exhibit 6 show the household saving rate in Australia and six countries that saw house price booms in the lead up to the GFC. Household saving increased by 4 points in the 2-3 years after the house price peak in the GFC sample. If that were to happen in Australia it would completely swamp the modest policy boost.

Of course, the GFC is a harsh comparison. On the other hand, wealth effects are likely to be more powerful in Australia than elsewhere because house wealth is larger relative to income (Exhibit 7). That implies that any given percentage change in house prices in Australia could have a larger wealth effect than an equivalent percentage change elsewhere. This is also consistent with the fact that as house prices were rising, the saving rate fell further in Australia than it did in the GFC economies.

The math is straightforward: even a modest saving increase – say, 2% over two years – would offset the impact of the coming stimulus measures. Western Australia hints at what may happen. House prices have fallen for longer in WA than elsewhere and per capita consumer spending is now falling (Exhibit 8).

This is circumstantial evidence that saving does rise, after a lag, as house prices fall. In this context, even if lower mortgage rates and relaxed macro-prudential put a floor under house prices, it’s not clear that a turn in house prices will come soon enough to forestall a broad rise in saving. If saving does start to rise, recession will remain a risk.

RBA to keep cutting but not fast enough. The Aussie economy is bogged big time.

Comments are hidden for Membership Subscribers only.