Opinion: Households to be better off next year

By ASB Chief Economist Nick Tuffley and ASB Economist Jane Turner Over the past year, price increases for essential everyday items seemed to be relentless. Food prices, fuel prices, mortgage rates – all took a bigger chunk out of your hard-earned pay-packet. Despite earning more, households did not feel any better off. So how did the average household fare last year? After covering spending on essentials, households were left with a mere $200 extra in their pockets relative to last year (June 2008 year vs. June 2007 year) – but even then, it was only after changing spending habits considerably. In addition, the household balance sheet has taken a nasty knock, with finance company losses and falling property values. But light is on the horizon. Tax cuts, while not covering the rise in essentials, will ease the burden. Petrol prices are also down and consumers are feeling marginally less woeful. Increased dairy revenue is also starting to trickle around rural communities. However, households will continue to struggle on the wealth front; some savings are frozen by finance company/mortgage fund difficulties and house values are set to fall further in the short term. Uncertainty will remain, but households should be better off over the next year. Food and fuel inflation takes its toll - the relentless increase in prices Fuel prices were on a constant increase and supermarket discount dockets only got you the previous week’s advertised fuel price. Then dairy prices started to climb, with the staple student diet of cheese sandwiches becoming a luxury food. On top of this, high mortgage rates really started to hit home for those re-fixing a mortgage. It was a year of extreme financial strain for many households and consumer confidence took a sharp dive. The Household Economic Survey The Household Economic Survey (HES) is run every three years and is used to benchmark weights in the Consumers Price Index. It provides a reasonably accurate account of the ‘average’ household dollar spend on a particular good or service. The last survey was done for the June quarter of 2007. Therefore, we can use annual inflation to gauge how much extra it would cost a household to buy the same bundle of goods in June 2008. Of course, this is not an accurate reflection of how much more households are actually spending. When prices increase, we change our purchasing behaviour, buying less of a more expensive good and perhaps more of a cheaper substitute. Using the HES data, we are unable to account for such behaviour changes. However, we can split out different types of products: those that are necessary, and those that are more discretionary. For example, food and fuel are fairly difficult items to go without, and mortgage payments are pre-committed. Necessities cost $36 more per week We have deemed necessities to be food, housing and utilities, petrol and interest payments. The remainder of household purchases have more of a discretionary element to them. Households have faced a 7.4% increase in the price of necessities, which would amount to an extra $36 per week (or just under $1900 per year). Just to meet this extra cost the average household income needed to increase 3% over the past year. It is not surprising, then, to see in the retail trade survey that increased spending on food and petrol has resulted in less spending in other areas. But you can change the way you shop The key limitation of the HES is it does not capture changing purchasing behaviour. Given the considerably large shift in relative prices over the past year, how consumers change their behaviour is equally important. We have put together our own estimates of changes in expenditure in key items over the past year (unlike the HES, this is not an exhaustive list). We have taken aggregate estimates and then derived per household measures. Food prices eating into the budget Using data from the retail trade survey, we estimate that annual household expenditure on food increased 3.6% (approximately $366 per year). This is lower than implied by HES ($560 per year or an increase of 6.9%) and consistent with consumers changing their buying patterns, such as switching to home-brands. In addition, the retail trade survey implies that volumes in more discretionary parts of food expenditure (e.g. takeaway foods) have been cut back significantly - which has helped cap the increase in total food spending. Nonetheless, the increase in spending is considerable, especially so given NZ households are getting both lower quality and smaller quantities in return. Gas prices guzzles incomes The average household expenditure on fuel has increased by around $616 per year (almost $12 per week), up 16.6%. Again, given the 25% climb in petrol prices over the past year, this smaller increase in total spend shows that households are cutting back on fuel consumption where they can. Higher interest rates increases debt servicing, adding to financial pressures. Over the past year, the effective mortgage rate (that is the weighted-average mortgage rate paid by New Zealand households) increased from 8.6% to 9.14%. Last year’s round of OCR increases pushed mortgage rates up substantially, and anyone re-fixing over the past year conceivably faced a rate increase of 100 to 200 basis points. This increase translates to a 6.3% increase in the price of servicing debt. However, the stock of debt has also grown over this time. As a result, the total debt servicing cost (not including principal repayments) has increased 14% - an additional $2,011 per year per household. Summing up, the ‘average’ household is spending 9.8% more each year on the necessities, i.e. food, fuel and mortgage interest payments. This is equivalent $2,130 a year or around $40 per week. Earning more, but nothing gained On the other side of the equation, earnings from wages and salaries also increased. From the QES gross earnings, average household earnings increased 6% or an extra $2,350. That increase was enough to cover the rise in spending on necessities, but does not leave a lot extra left over. Good news: dairy revenue and tax cuts may ease the burden With the labour market softening, there will be limited scope to claw back purchasing power from higher earnings over the next year. However, there are a few glimmers of hope on the horizon. The past season’s dairy payout resulted in an additional $3.8 billion in dairy revenue. Sure it goes into a concentrated set of pockets, but this money does not just stay with the farmers for long. It trickles down, with increased dairy investment boosting construction and sales of capital equipment as well as contributing to employment and retail spending growth. Closer to home, the tax cuts due to kick in on October 1st are worth an extra $1.5 billion - or just under $20 per week per household. Nonetheless, an extra $20 in the weekly pay-packet or the dairy farmers’ windfall is cold comfort to many. The fact of the matter is increased prices of necessities chewed up most of last year’s pay rise. A knock in purchasing power is demoralising, with the average Kiwi simply not getting ahead over the past year. But household balance sheets looks less healthy On top of cash flow concerns, the household balance sheet has also undergone considerable changes. The finance companies that have gone into receivership (to date) have lost an estimated $870 million of household savings. In addition, there are the lost interest-earnings on the remaining money while receivers try recovering the most they can from failed ventures. A large amount of cash also remains tied up with finance companies in moratorium or suspended mortgage hedge funds, to the tune of $3.3 billion. The direct loss on households assets essentially means affected households will now have to save more now (and consume less) if they wish to return their nest eggs to their original value. Indirectly, the increased uncertainty on these investments leaves households more risk averse, and again likely to increase their savings buffer – if their budget permits. In addition to the finance company fall-out, property values are expected to fall around 6-7 percent over 2008 - removing $4 billion off the value of the housing stock. The reduction of wealth (on paper) will evaporate that feel-good factor which as been such an important driver of retail spending over recent years. Tough times for all Over all, NZ households were left financially worse off this year: price increases chewed up income growth and wealth has shrunk. Little wonder consumer confidence has plunged to its lowest points since the 1991 recession. Hardly surprising, increased spending on food and fuel has squeezed out spending on other goods. It has made for especially challenging time for both retailers and households alike, both now gasping for relief. The next 12 months? Fortunately, the worst should be over. Petrol prices have already showed some retracement and consumer confidence has perked up as a result. Sharp food price increases should be behind us. Interest rates are on the way down (although admittedly remain very high) but should provide some relief at the margin, particularly for prospective home buyers. Our export sector is expected to become a bigger driver of NZ growth, with the lower exchange rate, high dairy prices and rising meat prices will help increase export revenue. * ASB's weekly Economic Notes are available here.