Consumer caution points to sluggish spending recovery

The Westpac Melbourne Institute consumer sentiment index dipped 0.3 per cent to 82.2 in May, from 82.4 in April, as cost-of-living pressures continue to bear down on households. 

The index remains at historically low levels, with pessimists outnumbering optimists by nearly 20 per cent, although the report did offer some clues as to what an eventual consumer recovery might look like. 

In a sign of the prevailing mood, the survey found that those expecting tax relief from Stage 3 tax cuts - which take effect from July 1 - expect to save around 80 per cent of the extra cash.

You would normally expect a pass through into spending closer to 50 per cent.

That's an important point, particularly for the Reserve Bank. They are comfortable with where inflation is tracking, despite an upside surprise in the March quarter numbers, because they're seeing this weakness in household spending. 

If the RBA does have any concerns that the tax cuts could boost spending, then they may draw some comfort from our survey responses which suggest the impact is likely to be muted. 

If people are going to prioritise repairing and shoring up their finances as their income situation improves, then it could be quite a slow, grinding recovery for consumer spending.
 

There were two big developments heading into the May sentiment survey.

The first was the stronger-than-expected inflation data, which sparked concerns that the RBA may need to raise interest rates further. The second was the federal budget, which contained several measures aimed at easing cost-of-living pressures. 

Among the component indexes, the assessment of finances compared to a year ago and assessments of whether now was a good time to buy a major household item both declined.

That reflects a reduction in purchasing power due to higher inflation and tightening pressures on household incomes from higher interest rates and higher tax.

On the positive side, forward views around family finances and expectations for the economy over the next year and the next five years all improved slightly. 

There looks to have been a sizeable positive impact here from the federal budget, with clear support coming from those cost-of-living measures including the $300 electricity bill relief for every household and increased rental assistance.

Households have become more wary about interest rates rising over the next twelve months, with over half of survey respondents expecting them to be higher. But we did see inflation and interest rate concerns ease among those responding after the federal budget had been announced. 

Those budget measures were targeting a lower headline inflation rate in the near term and helped to instil a little more confidence that inflation would be under control.

Overall, conditions remain difficult for consumers. There is some light at the end of the tunnel: we are about to get some significant support for household budgets, particularly around tax, but it looks like it could be a slow recovery process going forward.

The silver lining to all this is that the RBA should feel comfortable about where it's sitting policy-wise and we think there won't be any further rate rises required to achieve the return to low inflation.  

To read Matt's full report, visit WestpacIQ.