The Australian Bureau of Statistics (ABS) released data on domestic economic flows including gross domestic product and consumption on Wednesday, highlighting that consumer spending on discretionary services remains strong despite the Reserve Bank lifting the cash rate for the fifth month in the row just this week. With the Australian economy continuing to run hot amid rising rates, it begs the question: Will the RBA continue to lift rates for longer than planned or pencil in bigger hikes?

Gross domestic product (GDP) rose 0.9% in the June quarter, up 0.2% since the March quarter. On an annual basis, GDP jumped to 3.6%, the strongest year on year growth since 2011-12. Private demand was one of the largest contributors to the lift in GDP over the June quarter. Private demand increased 0.9% over the quarter driven by a rise in household consumption, slightly lower than the March quarter where it increased 1.2%. According to the ABS, the growth in household consumption over the quarter was propelled by increased spending on discretionary services. During the June quarter, goods consumption remained relatively flat while service consumption gained 3.6%.

Consumption chart

Source: ABS

Despite the strength in service consumption growth, Chief economist at AMP Capital Shane Oliver is not worried about the RBA changing their approach.

“The data is broadly consistent with the Reserve Bank’s forecast,” he says.

As the RBA only begin to increase the cash rate in May this year, the impacts of the hikes would’ve had a relatively minimal impact on the quarter says Oliver. He believes that forward looking indicators tell a story different to the June GDP data.

“More forward-looking indicators such as consumer sentiment and housing are all pointing down, suggesting that from here perhaps it might slow down quite substantially,” he added.

This is a view shared by REA Group Economist Paul Ryan who says the June GDP figures met the expectations of the market.

Consumer demand for services has been recovering at a more than steady pace since it dropped off sharply during the June quarter in 2020. As restrictions began to ease and vaccination rates rose, the demand for travel services, restaurants and cafes began to improve, with service consumption surpassing pre-pandemic levels. Pent up service demand from two years of quarantine and stay at home orders will begin to dissipate according to Oliver. He forecasts that overall consumer spending will begin to decline in the month ahead and foresees a normalisation of distortions in service spending caused by the pandemic.

“Service spending is getting to the point where it’s largely run its course. Goods spending is already back around its long-term trend,” he says.

Households will reallocate their budget away from consumption

Like Oliver, Ryan shares the view that increases in the cash rate earlier this year were not accounted for in the June GDP data which showed strong consumer spending. He acknowledged the importance of expectations explaining that some households may have curtailed spending in anticipation of higher rates but specified that it isn’t how household cash flow actually operates. Consumer have built up strong savings buffers over the past couple of years, allowing them to spend more.

Ryan believes that households will reallocate income away from spending as rates continue to rise and savings buffers fall. He believes the high level of consumption that has occurred is due to a combination of a tight labour market allowing individuals to access higher wages and record low interest rates.

“The spending that households have conducted over the past two years have been because they received additional disposable income that they saved. So, there will be some readjustment away from spending,” he says.

In his speech on Thursday, Governor Philip Lowe acknowledged that the RBA’s path in terms of raising rates is not set in stone and will rely on the changes in inflation and wages.

“How high interest rates need to go and how quickly we get there will be guided by the incoming data and the evolving outlook for inflation and the labour market,” he said.

In addition, he also acknowledged that the case for a slower pace of increases in interest rates has growth stronger as the cash rate rises.

Considering Oliver and Ryan’s forecast of a drop off in spending over the coming months, which may result in an ease on inflation, the RBA has an even stronger case to slow rate hikes as opposed to increase.