Halt in consumer spending could boost recession risk

Consumer spending in Australia is approaching a potential tipping point, economists warn

Halt in consumer spending could boost recession risk

Consumer spending in Australia is facing a potential tipping point, with the cumulative impact of surging inflation and rising interest rates posing a threat of a sudden halt in spending and increasing the risk of a recession.

The recent string of profit warnings from consumer companies indicates a potential downturn in spending, despite economists suggesting that interest rates may need to rise even further to control inflationary expectations, The Australian reported. The possibility of a cash rate increase from 4.1% to 4.6% by September looms, as the estimated likelihood of a recession in the coming quarters jumps to 50%.

While consumption has shown resilience in recent times, driven by pent-up demand after the late reopening of the economy and a robust labour market, signs of cracks are now emerging, The Australian reported. UBS highlighted that retail sales and consumption volumes have remained stagnant for several quarters, and the increased expectations of rising interest rates have significantly heightened risks for consumer spending.

“Our economic growth outlook has long been for a sharp slowdown by the December quarter amid even weaker consumption,” UBS Australia chief economist George Tharenou told The Australian. “But given companies’ updates imply a sudden stop of spending in the last month, the economy is at a tipping point. If the RBA keeps hiking, there is downside risk to our outlook, which would raise the risk of recession to about 50%.”

Housing market

Despite the previous sharp rate hikes by the Reserve Bank, the housing market has shown relatively little strain, with low mortgage arrears and recent increases in house prices. However, UBS pointed out that new data on mortgages suggests a recent spike in arrears, which is expected to further increase as a result of the recent rate hikes.

The challenges faced by Australian consumers, such as higher living costs, are now becoming evident, leading to a slowdown in spending and the possibility of a significant downturn in the retail sector in the 2024 financial year, The Australian reported.

A tipping point

Macquarie also warned of a tipping point, noting that the excess savings that previously supported spending growth have normalised, and consumers are now facing significant headwinds in the second half of 2023. The recent negative trading updates from consumer stocks indicate a notable shift in consumer behaviour over the past two months. Ross Curran, Macquarie's head of Australian consumer research, said that the brakes are being firmly pressed in the current environment, and consumer staples are preferred over consumer discretionary stocks.

Chris Nicol, head of research at Morgan Stanley Australia, also highlighted the earnings risks stemming from a tipping point in consumer spending. While some reduction in top-line expectations for 2023 has occurred, margin forecasts in many cases still remain above pre-COVID levels. However, these margin assumptions are likely to be tested as economic adjustments take place, Nicol told The Australian.

Deutsche Bank Australia's chief economist, Phil Odonagoe, believes that the Reserve Bank has more work to do.

“A slowdown in retail spending will likely continue, and we expect materially weaker outcomes over the second half of this year,” he told The Australian. “But we would argue the correct interpretation of this is more ‘back to normal’ than ‘plummeting’.”

Odonagoe argued that interest rates are still too low, emphasising that policy is not as tight as it was during the 2008 global financial crisis.

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