Household savings rate plunges to lowest level in decades

Among the many gloomy economic stats at the moment, one of the more worrying is the household savings rate.

During the COVID period the savings rate grew to more than 20% of income as lockdowns, government stimulus payments and extreme caution led to an extraordinary and unprecedented savings rate that is unlikely to be surpassed for a long time.

Fast forward to now and that savings rate has collapsed down to just 4% a year – below the inflation rate and certainly a reduction in per capita terms given our rapid rate of immigration.

It’s the mortgage, stupid

There is no secret as to why the savings rate is falling and, along with it, actual savings in the bank, as a combination of rapidly rising interest rates, high inflation and a lot of travelling after the cooped up COVID years combine to gradually remove those savings and prevent a recovery in the savings rate.

Of course, averages only show an overall picture and there will be some cohorts – most likely those with large mortgages and mortgages that have reset from super-low fixed rates – that will have very quickly exhausted their savings and will be struggling to keep their heads above water.

Then there will be others cohorts that have so far decided to keep the hammer well away from their piggy bank and are enjoying higher deposit rates on their savings as the banks slowly are dragged into paying better returns for savings.

Overall, though, the savings picture has certainly taken a sudden turn for the worse and has collapsed from one of the highest rates ever down to well below the long-term average growth rate and the lowest level since the late 1990’s – a period just before the GFC when asset values were flying ever higher and anyone who kept their money in the bank was viewed as a total sucker.

Of course, the GFC quickly changed that “assets at all cost’’ thinking and led to a flood of money back to bank deposits even as banks themselves started to look particularly dodgy after the collapse of Lehman Brothers.

How will savings recover from here?

So, what are some of the catalysts that might lead to a return to more normal savings rates in the Australian economy?

Well, the most obvious would be some relief on the inflation side of the ledger and there are some preliminary signs of that happening.

Although fuel costs and particularly diesel have remained elevated due to the Russian war in Ukraine and supply tightening through lower production by OPEC+, other supply bottle necks which have helped to cause rocketing prices have been slowly improving.

One of the more obvious of these is the gradual unfreezing of exports from China following on from its extended period of COVID lockdowns.

Very high prices for goods other than absolute essentials also act as a disincentive to keep spending, which should help to put more downward pressure on prices.

Interest rates are of particular concern here.

If interest rates remain at the current higher level for some time and the banks and other financial institutions start to compete harder for deposits, that would attract further savings from those who have the capacity.

It will also cause many investors to continue to move money out of assets and back into cash deposits, which are now showing such strong, risk-free returns.

However, continuing high interest rates will also keep up the strain on those with very high mortgages that are struggling to keep up their repayments – never mind saving anything.

Economic slowdown will reduce pressures

An economic slowdown, with or without a rise in unemployment, would also tend to put less pressure on prices and cause more people to seek out the safety of savings, although the obvious counter argument to this is that there will be less dollars circulating due to slower economic growth.

The final argument is that over time economies in general and the Australian economy in particular tend to muddle through.

After having recorded the highest savings rate for a long time during the COVID era and now the lowest for a long time in the frantically inflationary aftermath, the Australian savings rate is likely to “revert to the mean” over time as the economy deals with the various shocks that have come our way.

Savings have been useful but bad debt is really bad

One thing to note is that the build-up of savings during the COVID lockdown era when it was actually difficult to spend money has been incredibly useful in helping households to navigate the difficult inflationary period that followed.

That is worth keeping in mind at an individual level with savings an excellent shock absorber when trouble hits while elevated debt levels and associated repayments can greatly reduce the ability to respond to sudden changes in economic conditions such as rapid interest rate rises and general price rises for almost all products.

While good debt that is invested in assets with generally rising prices may overcome this lack of flexibility, bad debt such as that on credit cards, has very few redeeming features.