Consumers Get Back to Spending


By Michael Englund and Rick MacDonald While income growth remains small, U.S. consumers' wallets remain open. The latest confirmation of that trend came in the July report on U.S. personal income, released Aug. 30. Income posted a surprisingly small 0.1% rise in July (vs. economists' median forecast of a 0.4% gain), following sizable downward revisions in all the income data for 2004. But the other side of the report contained a surprise: Consumption surged 0.8% (vs. the median 0.7% forecast), with large upward revisions to previous months.

Looking more closely at the income figure, wages and salaries rose 0.4%, while proprietors' income (from individually owned businesses) dropped 0.5% due to a 28% decline for farms. In addition, rental income declined 0.6%, and personal current-transfer receipts -- which includes payments of old-age, survivors, disability, or health-insurance benefits -- dipped 0.8%.

ROBUST FIGURES. The income revisions for the prior months (June's growth was revised to 0.2%) were disappointing on their own, as the figures for government receipts of tax payments from households were not revised downward nearly as much. This left a renewed sideways trajectory for the ratio of household taxes to income, following three years of strong and steady declines, which suggests that the fiscal-policy party is over for tax cuts.

The disposable-income weakness dropped down to the savings rate, which fell to only 0.6% in July, from a revised 1.3% in June -- consistent with its pattern of bouncing just above the zero level. This lean savings rate is what we at Action Economics had expected before the surprisingly weak "real" spending figures were initially reported for the second quarter.

Economists had to look to the consumption data for upside surprises. As expected, spending was boosted by a 4.1% jump on durable items related to the sharp rebound in vehicle sales. But other components were also revised higher. And a flat chain-price index in July contributed to the encouraging spending outlook, leaving a very robust set of real (adjusted for inflation) spending figures as the U.S. enters the third quarter.

UPWARD REVISIONS. Higher-than-expected consumption is even more important then the income weakness. The chain-price deflator for nondurable items actually fell 0.4% in July -- an encouraging signal on inflation -- leaving a huge 0.8% real gain in consumption in July that more than offset the revised 0.4% June drop.

The July report has prompted an upward revision in Action Economics' third-quarter GDP estimate back to 4.3%, with a 4.1% real growth rate for consumption. Because consumption entered August at such a healthy level, we now see less upside possibility, so we've revised downward our retail sales forecasts for August to 0.8% overall and 0.7% excluding autos. Our August light-vehicle sales forecast has also been lowered, to 17.8 million units, as the seasonal surge we expect should now be capped by brisk nonauto sales and a savings rate at a surprisingly low 0.6%.

In total, the data through July now look much more like what we expected prior to the surprisingly weak June data. The savings rate is no longer posting a surprising uptrend, thereby showing consistency with the high levels prevailing for consumer confidence. Tax revenues are indeed stronger relative to income, and the June lull in spending is being followed by a rebound that will smooth out any perceived slowing in household spending. Englund is chief economist and MacDonald is director of investment research and analysis for Action Economics


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