The two main Australian political parties are in the midst of a heated battle over tax cuts.
And, we expect to hear a lot more about the topic in the coming months.
Tax cuts look to be the government´s solution to low wage growth.
We are all for it. After all, who is against paying lower taxes, right?
The Australian economy is growing steady.
In the first quarter of the year, Gross Domestic Product (GDP) saw a 1% increase in real GDP.
Commodity exports led the growth. Government and business spending also saw an increase.
Yet, while businesses and governments are spending, consumer consumption is weak.
Consumer spending is slowing
Slowing consumer spending is a big deal. About 60% of Australia´s economic output comes from consumer spending.
As you can see in the graph below, most of Australia’s growth in recent years has come from consumer spending and housing construction.
Source: AMP Capital
[Click to enlarge]
Housing has also been one of the main drivers of the Australian economy in recent years. Now it is tapering off…so is consumer spending due to low wage growth.
Government and business spending are picking up some of the slack.
But how long can this last if wage growth stays flat?
Low wage growth, high debt, and higher costs of living have meant that households are dipping into their savings to make ends meet.
As you can see in the chart below, the savings rate has been trending down in the last few years.
Source: Trading Economics
[Click to enlarge]
Property prices slide
Consumer spending could slow even more, as property prices keep sliding down.
Decreasing property prices could have a negative impact on the wealth effect. You see, when properties appreciate, households feel they are sitting on a lot of money, so they spend more.
If property prices start falling…well, you guessed it! It could mean households spend less.
It´s likely that home prices continue to fall as it becomes more difficult to get credit.
As Westpac recently reported in their June 2018 Market Outlook (emphasis mine):
‘Weaknesses remain, particularly around the consumer and housing. The consumer is vulnerable at a time of weak wages growth, high debt levels and slipping house prices. The housing sector is cooling as lending conditions tighten, with prices easing back from recent highs. Auction clearance rates in Sydney and Melbourne have slipped further to now be at below average levels.
‘Consumer spending is choppy (up only 0.3% in the March quarter) and ‘slightly below trend’ (up 2.9% over the year). Even the current pace of consumer spending appears unsustainable over the forecast period – we expect a slowing to 2.5% for 2018 and 2019. Spending has been supported by a drop in the savings rate, declining to 2.1% from 4.0% a year ago, with the scope for a further run-down diminished…
‘With weaknesses in consumer spending and housing we expect GDP growth to moderate to 2.7% in the year to December 2018 and then slip to a below trend 2.5% for December 2019.’
If consumers decrease spending, we could see a real economic slow-down.
In fact, RBA governor Phillip Lowe recently addressed this in a recent speech:
‘One area that we continue to watch carefully is consumption growth. Over the year, household consumption rose by 2.9 per cent. This is a reasonable outcome, although growth in the March quarter was on the soft side. Stronger employment growth has contributed to a pick-up in wage-related income and this is helping to support spending. At the same time, though, the level of household debt remains very high and the housing markets in Sydney and Melbourne are going through a period of adjustment, following the earlier very large increases in prices. Credit standards are also being tightened further. So we are paying close attention to household finances…
‘Over recent times, wages growth around the 2 per cent mark has become the norm in Australia. Some time back, the norm was more like 3 to 4 per cent. This downward shift in the rate of wages growth is clearly evident in the wage price index as well as in the more volatile measure of average hourly earnings in the national accounts.’
Average wage growth has gone from 3–4% to 2%. Even as unemployment continued to drop, it is currently at 5.4%.
Australia has been growing on the back of housing and consumer spending in recent years. Yet wages aren´t growing, costs are rising, there is high debt and we are looking at higher interest rates.
Tax cuts could provide some relief against mortgage stress, especially as costs of living keep rising.
Yet ultimately, we will need to figure out how to push up wage growth, especially as risks keep on building in the economy.
Any increases in interest rates or unemployment could bring Australia´s economic track record to the test.
Editor, Markets & Money
PS: Winter is coming. According to author and economist Harry Dent the next big crisis is at our door step. He thinks we could be about to enter an ‘Economic Winter’…one that could put freeze the Australian economy for years. If you want to learn more about Harry’s worrying forecasts, click here.