What’s driving consumption?

06 October 2010

Recent comments from Reserve Bank officials suggest that policymakers are increasingly concerned about the inflationary risks of having consumer spending growing strongly alongside the anticipated surge in mining sector investment.  As a result, it is increasingly important to assess the outlook for consumer spending and determine what factors are driving growth in this component of demand.

In the past year, consumer spending has remained healthy despite slowing retail sales.  This is partly the result of a resurgence in motor vehicle sales, which have provided a positive offset.  A reversal of this trend in the second half of 2010 would be good news for retailers.

But, with some areas of spending likely to rise more strongly than others, this should not necessarily be a concern for the Reserve Bank if overall consumption growth remains contained.
It should be noted that it is not uncommon for retail spending and motor vehicle sales to travel in opposite directions.  This inverse relationship has been particularly apparent in the past year, with car sales jumping more than 20%, while retail sales growth eased.  This is interesting given that similar factors – such as interest rates and income growth – tend to drive these different components of spending.

Thus, it could be argued that the increase in spending on big-ticket durable goods – such as motor vehicle sales – has contributed to the softer retail activity.

But, the start to the second half of 2010 has not been as strong for the automotive sector, with new car sales dipping in July.  Moreover, the number of households saying that now is a good time to buy a new car is declining off very high levels in the consumer sentiment survey.  This is driven by a range of factors including discounting, interest rates and the cost of petrol.  And, if spending on cars begins to soften, this could free up more income for households to spend on smaller purchases of retail goods.

Indeed, overall consumer sentiment has staged a bit of a comeback in recent months – as the RBA left interest rates on hold for an extended period.  While this will have been welcomed by retailers, policymakers are now looking to tighten monetary policy, which will have a dampening affect on the sector.

That said, within retail there is also likely to be some divergence between the industry sub-sectors.  For example, softening housing market activity will weigh on demand for household goods retailing, while spending on recreational items and at cafes and restaurants could continue to rise strongly.

This shifting composition of activity could see retail sales pick-up in the second half of 2010, but it does not necessarily mean that overall consumer spending will be as robust if purchases of big-ticket durable items start to moderate.  And, this will be a dynamic that policymakers will need to track closely in gauging the appropriateness of monetary policy settings.