THRIFTY AUSTRALIANS GEAR UP TO SPLASH THE CASH

Most of the preconditions are in place for a strong bounce in consumer demand. Consumer spending is shaping up to be particularly strong in 2014, which is a vital element of the rebalancing of the economy as the mining investment boom fades.

In recent years, consumers have been hoarding their cash and are saving about 10 per cent of their after tax income. The last time household savings were this high was in the 1980s. Consumers are responding to the great global economic and financial market uncertainty, grateful Australia didn't fall into recession and learning from what was a crazy period between 2002 and 2006 – where savings were zero or even slightly negative.

While this lift in savings is desirable in one sense, as it puts the household balance sheet and thus the sustainability of economic growth on a more stable footing, it has meant that the rate of growth in household consumption has been below trend.

If the recent lift in consumer sentiment translates through to a behavioral change that sees even a small fall in the saving rate and those savings are directed towards spending, the impact on consumption growth will be significant.

A factor that might prompt this scaling back in the pace of saving and in itself, might spark a spending lift, is the surge in wealth from the rise in asset prices, particularly in housing and stocks.

Over the past 18 months or so, the value of the Australian housing stock has increased by around $375 billion, while the value of the ASX plus dividends has increased by around $400 billion. A huge proportion of these gains is flowing through to the household sector and with it, is increasing financial security.

While much of this increase in wealth is locked up in the house people live in or in their retirement income portfolio which cannot be tapped in the near term, there is a clear and unambiguous confidence boost to the household sector from rising asset prices. There is also a potential cash flow effect as the better than expected wealth, capital gains and income for retirees, investors and everyday shareholders spills over to greater purchasing power and potential leverage.

The other issue that is setting consumers up, like a coiled spring, to lift their spending is the recent period of deleveraging.

Most householders with mortgage and other debt have used the last couple of years of falling interest rates to reduce their debt levels. This has largely been achieved by maintaining monthly repayments at a given dollar level and as interest rates have been slashed, the extra repayments are going directly into debt reduction.

Like the rise in savings, this is a good thing as it improves the balance sheet of the household sector.

What it also means is that the future appetite to take on fresh debt, to borrow to fund investment and therefore underpin further growth in spending is greatly enhanced.

If the household sector is comfortable with the current lift in asset values in concert with the relatively low level of debt, it is likely that some modest increase in debt will occur – perhaps linked to the housing market – which will underpin a strong lift in overall household spending.

Perhaps the catalyst for this lift in consumer demand will be a turn in the labour market. If the unemployment rate falls, wages growth edges higher and job security increases, the risk will be that household spending will increase at a particularly solid pace. This is certainly what the Reserve Bank is trying to achieve with the current accommodative stance of monetary policy and with its efforts to jaw-bone the Australian dollar lower.

If household consumption expenditure can accelerate to a 3.5 to 4 per cent growth rate in 2014, the bottom line for GDP growth will easily exceed 3 per cent, even with mining investment turning lower.

This would have huge implications for policy makers. No doubt the Reserve Bank would need to move monetary policy settings to a more neutral stance and the government would be raking in revenue from the GST, higher company profits and an improving labour market and the path to surplus would be greatly improved.

The framework is clearly in place for a rebound in consumer demand. All that is needed is for a trigger to ignite the pick-up.