Retail spending continues to boom, but how long can it last? Not as long as the Reserve Bank of Australia needs it to unless the labour market picks up soon.
Retail sales rose by 0.7% in October, beating market expectations significantly, to be 4.6% higher over the year. Growth continues to be driven by discretionary spending — the most cyclical category of consumption — indicating that consumers continued to be fairly buoyant heading into the Christmas shopping season.
The combination of low interest rates and increasing housing and financial wealth continues to prompt optimism. Interest rates are certainly doing their bit, encouraging households to bring their spending intentions forward exactly as intended.
Certainly interest rate cuts have provided considerable loose change for households and relief from cost-of-living pressures, and this has manifested itself in more iPads and HD televisions and the replacement of household goods. But I have to wonder: how long this can last?
Interest rates will not rise any time soon, unless the housing market goes bananas, and the labour market remains fairly weak — considerably weaker than the headline unemployment rate of 5.8% suggests.
On one hand we have low interest rates making households feel richer, while rising unemployment and uncertainty makes them cautious. The recent spending binge makes the outlook brighter for employment, but that outlook is still soft by any measure and suggests that households will become more, rather than less, cautious in 2014.
Obviously I expect labour market concerns to outweigh other factors but, at least for now, household optimism — inexplicable though it might seem — is welcome and is helping to support the Australian economy.
As the graph above shows, the last couple of years have been plagued by periods of optimism followed by a rapid slowing in spending growth. Don’t be surprised if this is just another temporary spike and spending growth slows to around 2% to 2.5% during 2014.
Spending increased in every state. Interestingly, growth over the past year has been weakest in Western Australia and strongest in Tasmania — a clear reversal of those economy’s fortunes in recent years. Growth in the other states is between 4.6% and 4.9% higher over the year to November.
When I talk about a rebalancing of the Australian economy, this is the sort of thing we should be seeing. Retail spending has clearly picked up in the non-resource states, while also slowing in Western Australia. We are already observing similar occurrences in other data such as building approvals and lending activity.
Although there are signs that the economy is rebalancing, we shouldn’t underestimate the task remaining before the Australian economy becomes a balanced affair. We still haven’t dealt with the most pressing issue: a mining investment cliff sitting on the horizon.
Some will suggest that the RBA should raise rates in response to the binge in household spending. Normally a strong household sector is a strong economy, but I think that view is premature, particularly in an environment where neither you nor I nor the RBA, for that matter, can predict just how large the eventual investment gap will be.
A conservative estimate is that the mining investment cliff will leave a gap of around 3% of GDP, while 5% is probably more likely. Consumption growth will not fill that gap, and we would need an unprecedented rise in dwelling investment to get anywhere near it. The RBA will want a much better feel of mining sector investment before it commits to its next move, and I’m not convinced they have that yet.
The recent pick-up in household spending is welcome and indicates that low interest rates are doing their bit, but we shouldn’t place too much weight on it — the bigger challenge is still to come.