The Economy: RBA Governor Sets Market Right On Spending

Reserve Bank Governor Glenn Stevens has once again demolished a storyline from the investment markets that had developed about retailing and consumer spending.

In a speech in Sydney yesterday, he reminded listeners and readers of his speech of that old adage, 'what goes up must come down'.

In this case it's the story about cautious consumers ruining retailing in this country.

He pointed out that the present caution and high savings rate will ease in the near future: when, he couldn't say.

And when that does, he warned us not to expect a return to the high spending, high consumption days of a decade and more ago.

Mr Stevens pointed out something that all the moaners had missed: that all big shifts in economic behaviour and activity come to an end eventually (remember the GFC and the way it crunched long spending boom, and the era of low risk and low cost money?).

This most basic point in all stories had been ignored by the henny pennies in the investment community and business and political media.

The newspapers and business websites have been full of retail doom and gloom, especially after David Jones downgraded its sales and profit figures a fortnight ago.

And it continued after the trading update and restructuring announcement on Monday from Premier Investments, which controls the Just Group chain of seven retail brands.

The RBA Governor first pointed out two years ago in a speech in the same venue (to the annual lunch of a Sydney charity, the Anika Foundation) that the rising level of savings by consumers would impact consumption.

He said, "As I said at a previous Anika Foundation lunch two years ago, the role of the household sector in driving demand forward in the future won't be the same as in the preceding period.

"The current economic expansion is, as we all know, characterised by a very large build-up in investment in the resources sector and expansionary flow-on effects of that to some, but not all, other sectors of the economy.

"It is certainly not characterised by very strong growth in areas like household consumption that had featured prominently in the preceding period."

It took the best part of 18 months for that message to get through to the markets, especially analysts and investors.

Then when that proved to be an accurate prediction (with downgrades from the likes of Woolworths back in February a major trigger), the prediction became a reality in the minds of many in the markets.

Other factors have intruded the lingering impact of the Queensland floods, the rise in inflation (mainly due to higher banana and other fresh food prices and rapacious state governments) and the nosy and at times stupid political discourse, led by Tony Abbott and compounded by Julia Gillard and Bob Brown.

Now it is gospel that the household sector is in a recession (as claimed by an analyst at Perpetual this week).

And it's not. The 6% rise in 4th quarter sales by Woolies is a sign that not all retailing is hurting as much as it did earlier in the year.

Car sales remain solid, housing approvals are edging higher, employment remains solid, with growth slowing from the previous high levels and the trade account and terms of trade continue at near record levels.

But the silly recession 'we'll be ruined' story persists, with some media reports extrapolating and talking about secular changes for retailers and the sector as a whole.

That's nonsense. Sure we are looking at a period of low growth for the sector, but it is not doom and gloom and impending collapse. Nor is the internet to blame, either.

Yesterday Mr Stevens told the lunch that the country's subdued household spending will likely rebound "at some point" as consumers gain confidence in the sustainability of the mining-led growth.

"As a better sense of the degree of persistence is gained, people will probably be more confident to spend than perhaps they are just now," he said.

"It is entirely possible that, were some of the current raft of uncertainties to lessen, the mood could lift noticeably, so I don't think we need to be totally gloomy."

But what will happen when consumers relax and start spending, will it be yippee? Nope, there will be a much more balanced rate of consumption where spending will roughly match income growth.

Or as Mr Stevens asked yesterday what is 'normal'? Will the 'good old days' for consumption growth of the 1995-2005 period be seen again?

"I don't think they can be, at least not if the growth depends on spending growth outpacing growth in income and leverage increasing over a lengthy period.

"A rapidly rising saving rate isn't normal, but nor is a continually falling one.

"While the rise in the saving rate has been unusually rapid, the level of the saving rate we have seen recently looks a lot more 'normal', in historical perspective, than the much lower one we saw in the middle of last decade.

"A return to those earlier sorts of growth rates for consumption would instead require, and could only really be sustainably based on, a continuation of the faster pace of income growth we have seen since about 2006.

"To the extent that that income growth has been a result of the increase in the terms of trade, however, it probably won't be sustained at the same pace.

"The level of income will probably stay quite high - above the level implied by the earlier trend - unless the terms of trade collapse.

"But the rise in the terms of trade has probably now come to an end. So the rate of growth of per capita income could be expected, all other things equal, to moderate from its recent unusually strong performance," he said.

And the key to the future is simple (but don't tell the dithering, blathering pollies in Canberra and elsewhere).

Mr Stevens said yesterday in his concluding remarks that it was all about continuing to improve productivity so that we can generate rising income when the boost of the terms of trade finishes.

"The thing that Australia has perhaps rarely done, but that would, if we could manage it, really capitalise on our recent good fortune, would be to lift productivity performance while the terms of trade are high.

"The income results of that would, over time, provide the most secure base for strong increases in living standards.

"That sort of an environment would be one in which the cautious consumer might feel inclined towards well-based optimism, and re-open the purse strings."