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The Australian economy is entering the trickiest part of its rebalancing phase to more than offset falling mining investment spending and contained government spending with stronger spending by households eventually promoting a lift in non-mining business investment spending too. If this rebalancing occurs, and throwing in some help from stronger exports too, economic growth should settle in to a 3-4% annual GDP growth groove in 2015, helping to whittle down the unemployment rate over the next year or two which, in turn, should help to underpin even more household spending and business investment spending. Getting this virtuous growth cycle to fire up is largely dependent on how well household spending lifts over the remainder of 2014 and the omens on that front have become mixed. The problem is that household income growth has been and is likely to remain soft. If households are to spend more freely, it can only really happen if they are prepared to save a smaller proportion of their income.

Between 2002 and 2007 Australian households never saved more than 4% of disposable income and at times in the period actually spent more than their entire disposable income generating a negative household savings ratio. This period of low to non-existent saving, but strongly rising household spending, was assisted by several factors. The most important of these factors were strongly rising household disposable income – a combination of rising wages and a series on annual income tax cuts – and ready access to credit at historically low borrowing interest rates.

The global financial crisis in 2008 brought an abrupt halt to the free-spending ways of the previous five years by threatening to reduce sharply growth in household income while at the same time reducing access to finance. Even though the Government in the early period of the crisis delivered special payments to households, the sharp disruption to households’ sense of economic well-being caused a marked shift to caution in household spending behavior.

In 2008, the household savings ratio jumped from 4% to over 12%, a level not seen in a quarter of a century. Household caution persisted for the next four years with the household savings ratio meandering around the 12% mark. Over the past two years, the household savings ratio has started to drift down, permitting household spending to start to lift even with annual wages growth languishing at a 15-year low of 2.6% y-o-y. In Q1 2014, the household savings ratio was 9.7%, down from 10.7% a year earlier. That fall in the household savings ratio materially contributed to the 2.8% y-o-y improvement in household consumption expenditure in Q1 2014 as well as the 8.0% y-o-y lift in residential housing expenditure over the same period.

Crucially, household consumption spending and spending on housing will need to grow even faster over the next year than they did in the year ending Q1 2014, if the GDP is to grow at better than 3% pace. There are big hurdles to growth in the next quarter or two. The sharpest part of the fall in mining investment spending is imminent. The sharp contribution to growth from exports in Q1 will also settle back in Q2 and probably Q3, although it should be stronger beyond.

As has been the case over the past year, growth in household income will be skinny over the next 12 months. Annual wages growth is unlikely to accelerate from the current 2.6% (sub 2.9% annual CPI) pace in the current still quite soft labour market. There will be no boost to household disposable income growth from government tax and benefit changes – rather the opposite with the benefit from scrapping carbon tax swallowed up a 0.5 percentage point lift in medicare levy starting July 1st , the beginnings of the funding of the National Disability Insurance Scheme, as well as the income tax levy for higher income earners and changes to family payments down the track announced in the May Budget. If households are to spend more in 2014-15, and sufficiently more to rebalance the economy, a further reduction in the household savings ratio will need to do the heavy lifting.

The need to encourage the household sector to cut back the proportion of their income that they save adds to reasons why the RBA will be keeping its cash rate stable and low for some time yet. It also implies that even if there are signs of over-exuberance in households demand for housing finance and lenders are starting to relax their lending standards any concern about financial stability will be tempered probably by the need not to prevent the household sector from spending more. Saving is not a virtue in Australia 2014-15.