The Unstoppable European Consumer?

Last year was supposed to be the year Europe stopped spending. The thinking went that the surge in prices would leave us all unable to afford our existing way of life. Spending on just about everything except the essentials would grind to a halt. A recession would follow with job losses everywhere and a collapse in discretionary consumer share prices. 

It was supposedly the goal of central banks. Higher interest rates on loan repayments would cause an even larger drop in spending. While more rate increases are ahead, we have yet to see the most pessimistic scenario emerge. We’re still here, the consumer is still spending, and we’ve entered 2023 with no signs of it stopping. 

But underneath this reseliance is an engine running low on fuel. Many of the drivers of consumer strength in recent times are pandemic related and cannot go on forever. To understand the consumer, we must dive into the other moving parts of the household accounts. Like any car, you don’t see what’s really going on until you get under the hood. 

Where inflation has risen, so too have incomes, and this has led many to believe there is no problem. In Germany, for example, disposable income in the household sector is up 6.7% in the year to Q3 2022. 

You might interpret this as the average German getting a large pay rise, but there are many moving parts. Not only are existing staff being paid more, but there are now more of them. Average wages are up 2.7%, but the number of employees at work is also up 2.6%. These trends combined have added €101bn to German disposable incomes. 

The problem is that a mix like this won’t be repeated in 2023. Wages will grow, but employment won’t. Wages growth should exceed 2.7%, but this won’t unlock extra spending. With double-digit inflation, you need double-digit income growth just to stand still. Anything less and spending should decline. 

2022 also saw growth of €92bn from other sources like interest received, rents, corporate dividends, and sole trader incomes. If wages are the engine of the household sector, these are the smaller car parts you never hear much of. You’re not quite sure what they do, but you know the car won’t move without them. 

Taken together, disposable incomes are now higher by €136.8bn after taxes, equivalent to 3.6% of German GDP. This is seismic, and we observe similar growth in other European countries. But can any economy repeat this trick in 2023? We doubt it. 

So higher incomes have thwarted a fall in consumption to date, but which types of consumption? Essential items like food and energy are mostly inelastic, meaning the overall level of spending is heavily driven by prices. People generally don’t increase their units of food consumption. If more is spent on essential items, less can be spent on discretionary items. 

Across Europe we find significant divergence in the mix of essential and discretionary spending in the past year. We can explain most of this by the level of government support for energy prices. Spending on essential items has grown by just 4.7% in Spain and 7.8% in France. Both have capped the price of energy to households. In Italy, where fewer supports are in place, spending is up by a hefty 19.1%. 

The overall merit of these policies is hotly debated, but no one disputes that it gave immediate breathing space to households. More income became available for discretionary spending than would have otherwise been the case. Even in countries with fewer supports, discretionary spending still rose. In Italy, it is up 7.4%. This explains the lack of profit warnings from companies in the discretionary consumer space to date. Their incomes are up, against all odds. 

However, the picture deteriorates when spending is inflation adjusted. We estimate that real discretionary spending has yet to surpass its pre-pandemic level in the eight largest Eurozone countries. Not one has fully recovered, even with those generous government supports in place. This means fewer goods purchased online, fewer nights in hotels, and fewer trips to local restaurants. 

Furthermore, the discretionary purchases being made today are being funded from a dwindling pool of pandemic savings. The French household savings rate before the pandemic was 16%. It reached a high of 23% in 2020 before falling to 18% by Q3 2022. Consumers are coping by leaning on these savings. 

The immediate impact of this fall in savings is being felt in the asset management sector. Where the pandemic years saw strong inflows, last year saw outflows. Combined with falling equity and bond values, the sector faced a miserable year. 

The discretionary consumer sector may be next to feel this misery. The savings rate will soon normalise. And then what? There’s a limit to how much households will lean on savings. If discretionary spending is the car that drives the European economy, we may soon see it stall. 

David W. Higgins is an analyst at the Dublin-based research firm Carraighill.  

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