The Constant Investor: How concerned are you about the Australian economy?

Energy costs set to curtail disposable income and business profits

There is is no getting around the reality that rising energy costs represent a headwind for growth and consumption, especially in an environment of elevated household debt levels. At the same time however, the RBA is well aware of these risks, and the downside from these developments will likely feature in the bank’s deliberations over coming months.

Rising energy costs are crucial for both households and business, as energy consumption is non-discretionary, and can’t in any practical sense be reduced. A rise in energy costs therefore directly reduces household disposable income and business profits, as few businesses are in a position to fully pass on the cost increase. Consumers are also likely to treat the increase in energy costs as permanent in nature, and lower their spending in both current and future periods. There is no expectation for the price hike to be given back. Despite these concerns, many in the economics profession will be quick to remind us that the bottom line impact on households depends on other factors as well.

Household debt levels are extremely high, but at the same time interest rates are low. This has kept interest payments as a share of disposable income relatively stable over recent years, and helped lower risks from higher debt levels.

The RBA is also likely to consider energy costs and debt levels in determining whether additional policy support is needed. This approach was evident in the RBA’s treatment of out of cycle mortgage rate increases, which saw the cash rate kept lower to offset this. Even with RBA support, however, over the longer term the loss of income to higher energy costs will require greater gains in productivity growth, in order to maintain current living standards and see them rise over time.

Tamar Hamlyn, Portfolio Manager, Macroeconomics

To access the full article, please visit The Constant Investor website (subscription required).

How concerned are you about the Australian economy?