• The RBA is uncertain about how households will react to an extended period of low income growth and housing market weakness should current trends remain.
• Ian Harper, a member of the RBA Board, also discussed the risks to household spending from an unexpected shock in an interview this week.
• Combined, economists at the National Australia Bank believe the RBA has “shifted the dial a notch or two on risks to consumption growth”.

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After helping to power Australian economic growth in the June quarter of this year, you’d think policymakers at the Reserve Bank of Australia (RBA) would be growing increasingly confident that household spending will be able to underpin economic growth in the period ahead.

Indeed, despite falling home prices in many parts of the country, including in Sydney and Melbourne, household consumption — the largest part of the Australian economy at just over 55% — grew by 0.7% in real terms in the three months to June, leaving the change on a year earlier at a decent 3%.

Prior strength in employment growth undoubtedly helped households to sustain their spending levels.

However, based on the tone of the RBA’s October meeting minutes, rather than growing more confident about the outlook for spending, the RBA’s concerns appear to be growing.

The RBA noted “uncertainty about how consumption would respond if there were an extended period of low income growth, and/or declining housing prices”.

To economists at the National Australia Bank, the commentary suggests the RBA has “shifted the dial a notch or two on risks to consumption growth”.

The uncertainty is understandable given the combination of falling home prices, weak income growth and falling household savings rates this year.

In the June quarter, the ABS reported that Australia’s household savings ratio fell to just 1%, the weakest level since before the GFC. So the buffer to sustain spending levels is razor-thin without household opting to dig into existing savings.

And there’s likely to be little near-term boost to household incomes ahead, even with a noticeable improvement in labour market conditions over the past two years.

Even the RBA acknowledged that there’s likely to be much improvement, noting that the national accounts measure of average earnings growth “had been weak in the June quarter and had increased by only 2% over the year to the June quarter”.

Currently, the RBA expects that wage growth, the largest component of household income for the vast majority of families, is only likely to increase “gradually” as slow progress is made in reducing underutilisation in the labour market.

And then there’s the prospect of continued declines in home prices in the coming years, led by an expectation of further weakness in Melbourne and Sydney.

Already this year, the median home price in Melbourne has fallen 4.6%, according to CoreLogic, with the decline in Sydney not far behind at 4.4%.

There’s already some evidence emerging to suggest this is having an impact on discretionary spending with new car sales falling by 1.5% nationally in the year to August, according to VFACTS, including a 4.1% drop in New South Wales over this period.

On top of significantly softer retail spending in July and August, it underlines why the RBA remains cautious, particularity should falling home prices lead to a distinct shift in behaviour from households.

Speaking to the Wall Street Journal earlier this week, Ian Harper, Reserve Bank of Australia (RBA) Board member, expressed his own concerns.

“People have been running their saving down to maintain their level of consumption, but there has been no growth in incomes,” he told the WSJ.

“At some point you might expect people to say that they are not running down their savings any more because don’t see the increase in wages we’ve been expecting to come along.

“You don’t want to precipitate that by either encouraging savings to pick-up again or to spook people into a situation where they feel they need to pull their horns in.”

While Harper was referring to a potential shock from an earlier-than-expected increase in official interest rates, there’s a clear risk that a prolonged period of housing market weakness could lead households to divert more money away from spending to savings.

That’s not been seen as yet, but it is a risk, and one the RBA will undoubtedly be monitoring closely in updated retail spending and consumption data ahead.

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