US: Consumer spending should lose steam

Economic outlook - 9/28/2016

Consumer spending could continue to grow in 2017, albeit at a slower pace. Household disposable income is likely to be buoyed by wage growth, which should outpace inflation. Our forecasts could be revised after the results of the presidential election.

GDP growth in the USA has historically been driven by consumer spending, whose share of GDP has risen from 60% in the 1950s to around 70% today. Despite this trend, consumer spending growth – like GDP growth – has slackened (see left-hand chart). It slipped from a record 3.2% in 2015 to 2.6% so far in 2016 and could slow even further in 2017. It is nevertheless likely to be one of the only components supporting US GDP growth.

Household disposable income up despite the recent rise in oil prices
Retail sales continue to grow by around 3% per year, and consumer confidence remains solid (see righthand chart). Yet growth in consumer spending will depend on the following variables: 1. real disposable personal income, which may be affected by real wage growth and by tax changes following the elections, 2. inflation, which can reduce household purchasing power, and 3. fluctuating oil prices, which can influence consumer buying behaviour and the level of household savings.

1 – Household personal income breaks down as follows: 71.8% gross wages, 18.6% property income (dividends, interest, rent), 9.6% social benefits (net of contributions). And on average, the tax levied on this income is 12.2%. Each of these subcategories can affect consumer buying decisions and, ultimately, GDP growth.

  • When it comes to wages, opposing forces are at work. Wages are pushed upward by factors including full employment, the high number of job openings and the mismatch between the labour market’s needs and the skills on offer (see left-hand chart). But at the same time, wage growth is held in check by a levelling off in the labour force participation rate (the labour force is composed of people working or actively seeking work. The participation rate is the ratio of the labour force to the totalpopulation in that age range (16-64 years old). and declining productivity, which erodes margins (see right-hand chart).

  • Net household wealth affects buying decisions. First, rising property and financial markets feed consumer confidence. Second, when the markets are trending upward, households’ borrowing capacity increases as the value of their collateral rises (e.g. real estate). Household lending has expanded by 1.6% since the start of the year, and banks’ lending conditions to households are generally accommodative. Only auto loan conditions have tightened (see left-hand chart); banks are much more cautious now following several quarters of strong growth in auto lending (+11.2% in 2015), driven in part by a catch-up effect following the crisis. The default rate edged upward to 3.5% in Q2 2016, and interest rates are also up slightly.
  • Tax rates will depend on who the next president will be. Donald Trump has proposed income tax cuts across the board, which would boost consumer spending in the short term. But the Republican candidate has little support within his party, and his proposal would have trouble getting through Congress. Hillary Clinton’s tax plan would not affect consumer spending because it would only raise the taxes on the wealthiest, whose spending behaviour would change little.
  • Household savings grew when oil prices fell in 2014 and 2015 (see right-hand chart below). Savings levels have gone down in recent months, however, reaching 5.7% of disposable income in July 2016. This limits consumers’ ability to ramp up their spending.

2 – Inflation is expected to accelerate in the next few months, and this will have a bearing on consumer purchasing power.

  • Inflation should reach 2% by the end of the year for two main reasons: first, stable oil prices will affect year-on-year price increases (through the base effect); second, the dollar has been relatively stable so far this year, and this has reduced downward pressure on import prices and thus on inflation. Under this scenario of rising prices, real interest rates may decline on the one hand, which would boost household borrowing and spending, but on the other hand real wages could also drop, which would undermine consumer purchasing power.
  • Despite higher inflation, the wage-price spiral (see box on next page) could have trouble kicking in. In effect, rising inflation will have more to do with stable oil prices than with GDP growth. This means that productive inputs will simply be more expensive and drive up production costs. Assuming that companies are price-takers, which means that domestic demand is not high enough for companies to set their prices, their margins may narrow and wages may struggle to increase significantly. Prices may therefore increase at a faster rate than wages for a short time (see lefthand

3 – Fluctuating oil prices could continue to influence household consumption behaviour. For example, every household saved an average of USD 115 in 2014, USD 790 in 2015 and USD 180 up to now in 2016 (USD 1,085 in total) thanks to lower oil prices. All of this money may not have been spent, but household savings grew and expanded American households' safety cushion.

The White House’s Council of Economic Advisers estimates that consumers spent between 40 and 80 cents of every dollar saved on lower oil prices.

- According to scenario 1 (see table below), under which each household spends 40 cents per dollar saved, around USD 12.8 billion more has already been spent on consumer goods in 2016.
- According to scenario 2, under which each household spends 80 cents per dollar saved, additional spending amounts to some USD 25.5 billion.

These are significant sums when compared to recent budget increases, for example, which were around USD 80 billion over two years.

 Other scenarios could come into play further out:
- If oil prices remain stable at around USD 45/barrel, which is the likeliest situation, every household would lose USD 59 in 2017 (see table below, hypothesis 1).
- If oil prices rise, ending 2017 at USD 60/barrel, this would reduce average household income by USD 218 (hypothesis 2).
- If oil prices fall further, with year-end oil prices at USD 30/barrel, this would boost household income by USD 109 (hypothesis 3).

These variables influence consumer spending and savings. Under the core hypothesis of stable oil prices, households would continue dipping into their savings, reducing their reserves for future spending. Household savings rates are only likely to hold steady or increase if oil prices were to fall again.

Conclusion: consumer spending should continue to grow, but at a slower pace
- At the beginning of 2016, consumer spending increased by an average of 2.55% year-on-year. We expect it to expand a bit more slowly in 2017, between 2.10% and 2.40%. It will nevertheless remain the main driver of US GDP growth (annual GDP growth would have been around -0.4% in the first semester without this component).
- There are several factors behind this expected slowdown: slowly accelerating wages, declining savings, inflation (which is eroding household purchasing power), and stabilising oil prices. Consumer spending will also be directly affected by tax changes the new US president seeks to implement in 2017.
- Because consumer spending should remain a key driver, we don’t expect a recession in the USA in 2017.


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