Consumers are fragile, handle with care

The Reserve Bank’s latest financial stability review suggests businesses are holding up pretty well. But appearances can be deceiving.

At first glance, the Reserve Bank’s latest financial stability review suggests businesses are holding up pretty well, considering consumers have been battling cost of living pressures for quite some time. But appearances can be deceiving.

On the plus side, revenue growth has held up and profit margins for both large and small businesses are not much changed from a decade ago, according to the Reserve Bank's analysis of both data and intel from its business liaison program. Higher labour costs, insurance, electricity, warehousing, logistics and rents have been offset by reasonable sales, cost cutting (where it can be found) and the ability to raise prices.

But as time passes, this shiny veneer of prosperity is under increasing stress. 

Just like the savvy households that fixed their mortgages when rates were low, many large businesses did the same. Many small businesses got access to cheap finance through their banks which was provided by the Reserve Bank’s $188 billion Term Fund Facility. But as monetary policy has been tightened, the fixed period loans have expired and the Facility has closed, businesses are facing higher interest costs. 

The Reserve Bank’s review noted that earnings, relative to interest rate expenses, are declining for some businesses and some loans have had to be restructured.

Governments’ pandemic support, like the JobMaker Hiring Credit, recovery loans, plus payroll, rent and land tax relief – which kept many businesses out of insolvency in 2020-2022 – are done, and there’s no more coming.

And the Australia Tax Office, motivated to find revenue for fiscal recovery, is getting tougher on businesses by enforcing actions on unpaid taxes.

It’s getting hairy out there.

There were just under 11,700 insolvencies in the year to August. That’s a record, although not an alarming one. But in accommodation and food services, there was an almost doubling in insolvencies – to 620 – in the June to August months, compared to 2023. 

Reserve Bank Governor Michele Bullock said in recent parliamentary testimony that “there is going to be an increase in insolvencies, and in fact, that’s part of the process of making sure that resources get to businesses that are productive and profitable.”

The short-term solution is straightforward: higher sales.

Yes, there are other ways. Productivity growth, unlocking of supply constraints, more efficient regulatory processes and a better tax system would all be helpful – not only to the current cycle, but also to the economy’s long-term prospects.

But in the short term, higher consumer spending is needed. 

At around 50 per cent of GDP, and the primary source of most non-exporting businesses sales, household consumption will be the difference between more insolvencies, and the preferable U-turn to the next upswing.

Positive real wage growth, personal income tax cuts and government support like electricity rebates and cheaper public transport are fresh financial supports that could give consumption a reasonable boost. 

There was a welcome 0.7 per cent rise in retail sales in August. It may be a sign of better times in the second half of 2024. But it could also just be warm early spring weather. 

Most helpful, of course, would be a series of interest rate cuts. 

It seems increasingly likely that the start of the rate cutting cycle is now less than six months away. 

But the Reserve Bank won’t give mortgage holders solid guidance as to when to expect this, because it can’t. 

If the first rate cut comes too soon – and reignites the inflation fire before it’s extinguished – rates may have to go higher in 2025. If the rate cuts come too late, the depleted consumer will drag the business sector down too. 

Exogenous factors matter to the timing of rate cuts too. Like the threat of higher petrol prices due to the Middle East conflict which will lift headline inflation.  And while it can be ‘looked through’ for a while, if consistent and persistent, the Reserve Bank won’t be able to completely ignore it.

While household disposable incomes are the main determinant of consumer spending, atmospherics are also important. 

Worries about community safety, climate, cyber security, global conflict and even election campaigns   are not conducive to a happy or relaxed consumer. Just look at the consumer sentiment numbers. On both the ANZ-Roy Morgan and Westpac-Melbourne Institute measures, current readings show deep pessimism, even though there has been a small bounce in recent weeks.

Consumers are mad as hell about inflation.  The recent EY Future Consumer Index showed that 4 out of 5 consumers were concerned about rising living costs and 61 per cent are spending less on non-essentials. This is why the recent ACCC interim report into supermarkets raised the ire of shoppers. Even the suggestion that supermarkets have been less than fully honest is met with anger.

We’ve been advising our clients that fragile consumers need careful handling. Consumers are being drawn to deep discounts and promotions, highly aware of promotion cycles.  Higher list prices are the first way to ensure customers go looking elsewhere or stop looking altogether.  

And price matters more and more the longer that inflation stays outside of the 2-3 per cent target band.   

Consumers are in no mood for anything less than exemplary behaviour from the businesses they transact with. They have shown they can, and will, spend less on everything, even food. 

Businesses must maintain a focus on cost-efficiency and keeping their customers’ trust.

The economy is relying on it.