Sales Drop Looms as Energy Prices Continue to Soar

Consumer Spending Crimped by Climbing Inflation, Slowdown in Real Estate

By Published on .

LOS ANGELES ( -- Three-buck-a-gallon gas isn't enough to tank the economy. But the cost of energy is dampening spending, and the cooling housing market will make it harder for consumers to tap home equity to feed their spending habits.
Oil prices are dampening consumer spending.
Oil prices are dampening consumer spending. Credit: AP

Spending slows
It's not a pretty picture: Consumers continue to spend more than they make, inflation is rising and high energy prices are taking a toll -- especially for poor households. June consumer spending rose at its slowest pace this year, and first-half inflation was the highest since 1990 (4.7%). Economic growth last quarter slumped to a sluggish 2.5% from the first quarter's 5.6%.

The good news: Oil is flowing, the economy is growing and consumers are adapting. Current energy prices aren't enough to tip the economy into recession. "People get used to a level of oil prices," said Standard & Poor's Chief Economist David Wyss. S&P asserts the economy could keep growing, albeit slowly, even if oil spurted to $100 a barrel (gas at roughly $3.60 a gallon) from the current $75.

Oil supply disruption fears
The bad news: Any disruption in oil supply, coupled with the housing slowdown and inflation, could slam the door shut on this five-year expansion.

Nigel Gault, chief U.S. economist at economic forecaster Global Insight, noted that oil prices over the past few years have been driven mostly by strong global demand, not by the sort of supply shocks that disrupted the economy in the '70s. But if a supply disruption sent prices to $100 or $125, " the risk of recession would be much higher."

Consumers have driven this recovery: In the quarter the recovery began, in late 2001, and for the first time in more than 60 years, consumer spending as a percent of gross domestic product topped 70%. Spending has been north of that mark in most quarters since until this year, when the economy has had two back-to-back quarters where consumers' share fell below 70%.

Living beyond their means
Consumers continue to live beyond their means, using yesterday's savings and tomorrow's debt load to pay for today's purchases. The nation's personal-saving rate has been negative since April '05. But a key source of cash -- home equity -- is drying up as housing-appreciation rates plunge. "People are going to be less able and less willing to keep borrowing against the value of their homes," Mr. Gault said.

There are signs that high energy prices are sapping spending. Consumer-spending growth dropped to 2.5% last quarter from 4.8% in the first quarter, and "a lot of that slowdown was related to energy prices," Mr. Gault said.

Higher gas prices have caused 77% of consumers to alter their spending, according to a July survey by Boston Consulting Group. Half of consumers said they have cut back on spending.

The effect of high gas prices is harshly different for rich and poor. The bottom 20% of households will spend an estimated 23.1% of after-tax income this year on gasoline and home-energy bills, according to an analysis by Advertising Age's American Demographics, up from 18.7% in 2004.

Consumer cut backs
Families living paycheck to paycheck have no choice but to cut back. Retailers are feeling the pinch: Wal-Mart's June same-store sales rose just 1.2%; comparable-store sales at Dollar General this year increased 1.7% through June.

The rich can absorb the expense; for them, the housing slowdown is far more material than the price at the pump. The top 20% of households this year will spend about 4.9% of after-tax income on energy vs. 3.9% in 2004, according to the American Demographics analysis. The rich have to get over the psychological barrier of $100 fill-ups for the Escalade, but they are still spending: Same-store U.S. sales at luxury retailer Coach last quarter jumped 18.5%.

The divergent views of rich and poor were clear in the University of Michigan's July consumer-confidence survey. The difference in overall consumer sentiment between the bottom and top thirds of household-income distribution was larger than at any time since the early 1980s, according to survey director Richard Curtin.

Families in the lower third were significantly more negative about their financial prospects and the outlook for employment and the economy. Poorer families, held hostage by high gas prices and rising inflation, have no choice but to put the brakes on spending. Bad news for them -- and for marketers that could find lower sales in store.
Most Popular
In this article: