Consumer spending hurt by falling house prices

Retailers should expect weak trading conditions to continue due an unsteady property market, according to a new report.

Citigroup economists Paul Brennan and Josh Williamson recently conducted a study on the main influences on how people consume goods and services in Australia.

According to their findings, changes in personal wealth, along with income and interest rates, play a big role in consumer spending.

However, changes in the value of household assets are also a leading determinant. Houses comprise about 60% of household assets, while financial assets such as shares or cash comprise the rest.

“We found that a 10% increase in wealth would increase final consumption expenditure by 1.7% in the following quarter,” the economists state in their report.

The problem for retailers is that most people’s largest asset is their home, and property values have been falling in recent months.

In the March quarter, house prices fell 1.7% nationally. The largest declines were in Brisbane and Melbourne, while Perth and Hobart recorded small gains.

Meanwhile, auction clearance rates were down in Sydney and Melbourne, and are drifting lower as threats of interest rate by the Reserve Bank turn off buyers.

Citgroup expects house prices to fall for another 12 months, which will affect household wealth and ultimately hurt retailers.

“The reduced pace of growth in household wealth will have a short-term, dampening effect on consumer spending,” Citigroup says.

But according to Citigroup, there is a positive relationship between household consumption and inflation.

“Our regression model of the consumer price index against consumption over the period of 1990 to 2010 has illustrated that a 1% increase in consumption would increase inflation by about 0.3%,” it says.

“Our forecast of positive, albeit below trend, household final consumption expenditure growth therefore suggests that households will have a mild and fairly constant influence on inflation in the future.”

“This may ease inflationary concerns that are already prevalent, particularly with the RBA’s Statement on Monetary Policy predicting inflation to remain at the upper end of its 2% to 3% target range for the next two years.”

“But we know that the RBA has already factored in a fairly neutral impact from the consumer. Instead, the RBA’s concern on inflation stems from higher business investment and incomes that are a result of the terms of trade shock in an economy with little spare capacity.”

“This is one of the reasons why we still forecast higher official interest rates, with household consumption remaining below the growth rates in the years prior to the GFC.”