Rate hikes, inflation hit households as consumption slows to lowest since Covid-19 lockdowns

Aggressive rate hikes and a massive lift in consumer inflation are starting to put the brakes on households with the consumption now at its lowest since Covid-induced lockdowns in 2021.

Aggressive rate hikes and a massive lift in consumer inflation are starting to put the brakes on households.

December-quarter national accounts data show the weakest growth in household consumption since the Covid-induced lockdowns in the September quarter of 2021.

Bad news on the economy was good news for asset prices as interest rate bets cooled, albeit slightly.

The S&P/ASX 200 rebounded from near its lowest point in seven weeks, Australia’s 3-year bond yield fell about 10 basis points to 3.50 per cent and the Australian dollar briefly hit a two-month low of US66.95c, after economic growth slowed to 0.5 per cent on-quarter versus 0.8 per cent expected.

Economists remained split between those expecting the Reserve Bank’s cash rate to peak at 3.85 per cent and others who were expecting a terminal rate of 4.1 per cent versus 3.35 per cent now.

But market pricing cooled to an implied peak of 4.2 per cent versus 4.3 per cent before the data.

Together with softer-than-expected employment and wage price inflation data, and a smaller-than-expected 7.4 per cent on-year rise in monthly CPI data for December, the weaker-than-expected national accounts data was welcome news for the Reserve Bank, though inflation is still too high.

Economists said the impacts of high inflation and sharply higher interest rates were becoming apparent as consumer spending rose just 0.3 per cent on-quarter versus a quarterly average of 1.7 per cent for the previous three quarters. Domestic demand was flat, even as the household savings ratio dived from 7.1 per cent to 4.5 per cent – below 5 per cent for the first time since 2018.

“Domestic demand stalled in the December quarter, the weakest result outside a lockdown period since June 2014,” said Westpac senior economist, Andrew Hanlan.

“This indicates that the economy hit a soft spot at the end of 2022.”

Net exports added a hefty 1.1 percentage points, driven by a services-led 1.1 per cent rise in exports and a 4.3 per cent fall in imports. But inventories subtracted 0.5 percentage points from growth amid weaker non-farm business inventories after run-up caused by one-off factors.

Home building activity fell 0.9 per cent, as a further 4.2 per cent fall in renovations work more than offsetting a 1.4 per cent lift in new home building. Real estate sector turnover fell a further 6.2 per cent after an 11.2 per cent plunge in the third quarter as rapid rate hikes began to bite.

Business investment fell 0.8 per cent on lower construction work and equipment spending.

Government spending rose only 0.2 per cent in both the third and fourth quarters, after rapid growth up to the March quarter 2022 due to the pandemic response. While nominal gross household income grew 1.6 per cent, real household disposable income contracted a hefty 2.2 per cent.

Growth in household discretionary spending was pared back to 0.4 per cent on-quarter, similar to the rate of non-discretionary which was 0.3 per cent for the quarter.

“Consumers look to have run out of room to keep lifting discretionary spending,” said RBC Australia Chief Economist, Su-Lin Ong.

The household savings rate is likely to fall further as incomes are squeezed by rising prices, rising interest payments, with strong nominal earnings growth not enough to compensate.

But while consumers are in worse shape than previously thought, the RBA will push the cash rate up by a further 75 basis points as inflation was still too high, according to Capital Economics.

“Looking beneath the headline, the figures paint an even less encouraging picture,” the forecaster’s Head of Asia-Pacific, Marcel Thieliant. Said.

Disposable income fell 0.7 per cent on-quarter due to higher income tax payments, while nominal consumer spending jumped 1.9 per cent. With inflation set to slow this year, real disposable income should rebound, but the “consumer is now in worse shape than we had thought,” Thieliant said.

He predicted GDP growth of 1.2 per cent this year, versus 1.6 per cent forecast by the RBA.

But while January’s fall in monthly CPI inflation to 7.4 per cent from 8.4 per cent in December was the first fall since February 2021, inflation is “merely back to where it was in November” he said.

“The monthly data have severe shortcomings, and the ABS recently stopped publishing a monthly trimmed mean measure because it was unable to predict the movements in the quarterly series.”

“As such, the RBA will need to see the next quarterly print, which will only be released in late-April, before it can conclude that inflation is on the decline.”

Goldman Sachs Australia Chief Economist, Andrew Boak, said the weaker than expected national accounts data were “unlikely to derail a series of further RBA rate hikes.”

“Beyond the usual quarterly volatility, we note that the Statistician flagged that severe flooding weighed temporarily on activity in the quarter, and we expect the RBA to remain focused on accelerating labour costs,” Mr Boak said.

He noted that nominal unit labour costs accelerated to an annual rate of 7.1 per cent on-year – far above its pre-pandemic average of 1.6 per cent on-year.

“This will keep upward pressure on the consumer price inflation,” Mr Boak said.

“We believe the RBA has more work to do to mitigate the risks to broader inflation as global peer central banks continue to lift interest rates.”