The cost-of-living crunch is set to hit many households hard in 2023

Most economists predict that Australia will manage to avoid a recession this year. However, it will be a tough year financially for many households as costs blow out for non-discretionary items. CEDA analysis shows that for low-income households, rent or mortgage interest costs are set to exceed 40 per cent of average disposable income. These households will need to cut discretionary spending by over 10 per cent in order to absorb increases in the cost of essential items without their overall spending increasing more than income. The cost of living crunch will flatten Australia’s economic growth, as household consumption growth is set to significantly slow this year. 

RISING COSTS

For mortgage holders, interest costs are set to more than double between 2021-22 and 2023-24. The Reserve Bank began increasing the cash rate from 0.1 per cent in May 2022, and current market expectations are for the rate to peak at around 4¼ per cent in the second half of 2023. The relative increase in households’ mortgage interest payments will be smaller, partly because some loans are at fixed interest rates and partly because actual lending rates are increasing from a lower minimum of around 2¾ per cent. However, most rates in Australia are only fixed for one to three years with the bulk set to expire before the end of the 2023-24 financial year. 

Renters also face higher housing costs as rents have grown strongly in the rebound from the COVID-19 pandemic. As of February 2023, asking rents for advertised properties are estimated to have increased around 20 per cent compared with 2021-22. These increases will gradually be passed through to sitting tenants as contracts expire and/or they move to new properties. Social housing tenants will be protected as their rents are typically set as a share of their incomes. If fast growth in asking rents continues this year, average rental increases by 2023-24 could be even higher. This is a real risk as rental vacancy rates nationally remain at a historically low level of under one per cent. 

Electricity and gas (energy) costs for households are also set to grow rapidly this year. Wholesale energy prices soared during 2022, and retail prices are set to reach record highs as these costs are passed through to consumers. The Government’s Energy Price Relief Plan should limit the extent to which further global energy market disruptions affect wholesale prices, but significant retail energy price rises are already built-in. 

As drivers are all too aware, higher petrol prices were felt more immediately in 2022. Futures markets do not indicate further oil price rises, but actual outcomes will depend critically on supply factors, particularly developments in the war in Ukraine. 

WHO IS MOST AT RISK?

Low-income households are most exposed to these rapid increases in energy and housing costs, which account for a greater share of their income. 

The ABS uses quintiles, or five equal-sized groups in terms of population, to analyse the distribution of income and wealth. Low-income households are those in the bottom group – they have an average disposable income of $764 a week or around $40,000 a year.

For low-income households renting or paying interest on mortgages, on average these expenses are set to exceed 40 per cent of average disposable income for their income group. Total mortgage repayments will be even higher, as this includes the repayment of principal on the loan. While repaying loans is a form of (forced) saving rather than expenditure, it nonetheless creates an additional strain on household budgets.

Energy spending by low-income households is set to grow from five per cent of their disposable income to seven per cent. This greatly outstrips the increase of 1.3 per cent to 1.7 per cent for high income households. On average, low-income households will need to cut their discretionary spending by over 10 per cent in order to absorb increases in the cost of essential items without their overall spending increasing more than income.

Within income groups, there will be large divergences in the cost pressures facing households. Those who have taken out large loans or are paying high rents are particularly exposed. While the average outstanding loan for mortgage holders in the top income group has historically been around double that of the bottom income group (and high income households are also around three times as likely to have a mortgage) there are exceptions and those with lower income are less able to cut other spending to meet repayments. Recent home buyers are particularly vulnerable as interest rates rise, with almost a quarter of new loans exceeding six times income in 2021 and early 2022. Meanwhile, large households and those living in houses with poor energy efficiency are more likely to experience energy-related financial hardship. As a share of their income, people living outside Australia’s capital cities spend more than twice as much as inner-urban dwellers on vehicle fuel, around one third more on energy but less on housing – while they are more likely to have a mortgage, the average loan size and thus interest payments are smaller for people living in regional areas.

THE BROADER COSTS

The cost-of-living crunch has macroeconomic implications. Growth in household consumption was the dominant driver of economic growth during 2022, as pandemic restriction ended. Households hit hardest by increases in the cost of living will need to reduce spending, with some forecasts indicating that private consumption could stall in 2023. Slow consumption growth means that other growth drivers such as investment or exports will be needed to avoid recession.

Lags in the transmission of some price rises to consumers – notably for energy and rents – will continue to push up inflation over the coming year. Treasury has estimated that energy prices could contribute around 0.75 percentage points to inflation this year, and rents could contribute almost as much again (depending on timing). This comprises a substantial share of the Reserve Bank’s two to three per cent inflation target. While the Reserve Bank may not be too concerned if they see moderation in the underlying wholesale energy and advertised rent prices, the Bank is highly alert to the risk that a sustained period of high consumer price inflation could push up inflation expectations, creating a self-fulfilling prophesy.   

Simple analysis of spending on key essential items makes it clear that there will be big distributional implications of recent rapid price rises. The scale of these effects means that government policy will need to be proactive in targeting support to those who need it most. The Albanese Government’s first full budget in May and detail around the Targeted Energy Bill Assistance will comprise key parts of the policy response.  Temporary and targeted support is required to avoid worsening the structural budget deficit or further stoking inflation.