Risk perceptions drive global consumer spending

Consumer spending patterns are driven by many factors, including age, gender and, most importantly, income fluctuations.

However, a major factor is consumers’ perception of future risks to the spending environment, which dictates the decision of whether to save or spend.

Key points

  • Consumer spending levels are dictated by how much disposable income they possess and their perception of risk in respect of future spending environments;
  • If the environment for income or spending is perceived to be riskier in the future, consumers often make the decision to spend immediately, and save in the future;
  • Perceptions of risk are shaped by the performance of the economy and particularly media interpretations of such performance;
  • In this regard, indicators of inflation and interest rates are the key determinants of future economic risk;
  • However, consumers may interpret these in ways that are at variance with the actual outlook for the consumer spending environment.


Consumer spending fluctuates broadly in line with economic performance. In times of economic prosperity consumers spend more; in times of economic depression expenditure falls proportionately:

  • However, the crossovers between periods of prosperity and depression are characterised by even greater spending fluctuations, as consumers try to estimate whether the change of economic environment will be short or long term;
  • These perceptions can help drive economic performance and in turn impact on the outlook for the consumer environment. If the economy is perceived to be heading into a slowdown or recession, consumers will fear a tightening of the wage and employment environment, curtailing their opportunities for disposable income growth. This may encourage them to begin saving for the perceived harder times ahead, reducing spending before there is a financial need to do so;
  • For example, in October 2007, US consumer spending remained flat in real terms over a year earlier. This reflects declining consumer confidence following the beginning of a credit crisis in the USA in mid-2007. In turn, falling consumer expenditure will worsen the slowing trend already apparent in the US economy, with the economy forecast to grow by only 1.9% in 2007, down from 2.9% in 2006.

Shaping risk perceptions

Perceptions of economic risk are often shaped by reports on the performance of certain headline indicators, such as inflation and interest rates:

  • These two indicators are viewed as giving an insight into the state of the economy’s health. In particular, inflation – as the measure of price increases – is monitored carefully by governments and central banks;
  • A measure of inflation’s importance is the fact that it was adopted as one of the five key requirements of the euro convergence Stability and Growth Pact that must be met by all EU accession candidates. To join the euro, candidates must maintain an inflation rate of no more than 1.5% above the three best performing countries in the EU;
  • For accession countries, failure to meet accession targets is a sign of economic failure in convergence terms. It may therefore have a highly negative effect on consumer confidence in these countries, which view EU accession as a guarantee of economic stability, bringing accompanying wage and job stability;
  • On the other hand, Bulgaria and Romania’s entry into the EU was delayed from 2004 to 2007, in part owing to their difficulties in meeting economic requirements. Consumer and investment spending rose in these two countries immediately ahead of their accession, as consumers became more confident of future economic stability, since it had been validated by the EU’s accession programme.

Inflation impact

Rising inflation can be interpreted both positively and negatively:

  • In countries with low economic growth, rising inflation can indicate improving economic activity and is therefore a positive signal for consumers. For example, in Japan where slow economic growth led to severe deflation in the 1990s, rising inflation is viewed as a positive trend. It signals reviving domestic demand and potential future opportunities for job and wage growth;
  • However, it is more common for inflation to be viewed negatively, especially in the current high oil price environment. For energy importers, the mounting costs of importing fuel are pushing up consumer prices directly (via rising fuel and heating costs) and indirectly as manufacturers pass higher product prices on to consumers. This erodes consumer spending power;
  • Most oil importers such as Argentina and Chile are experiencing such imported inflation. In November 2007, Argentina’s inflation was running at 15.0% year-on-year, up from 10.7% at end-2006 whilst Chile’s reached 7.4%, from 3.4% at end-2006. Rising inflation is eroding disposable incomes and consumer spending in these countries.
Year-on-year inflation rates in Argentina and Chile: 2001-2007

Source: Euromonitor International from IMF and national statisticsNote: 2007 figures are November 2007.

Global inflation in 2007 has largely been the result of higher energy prices rather than reviving economic activity and is therefore viewed negatively by consumers, since it reduces their purchasing power.

Interest rates impact

In general, interest rate rises are negative for consumer spending, while rate cuts encourage greater spending:

  • Interest rate hikes increase the incentive to save money and earn interest on these savings to finance future spending. Consumer spending therefore drops when rates increase;
  • In addition, rising interest rates reduce consumer purchasing power. It is more difficult for consumers to access credit, both for credit cards and bank loans such as mortgages. With regard to mortgages, rising interest rates are also passed on to mortgage payments, reducing disposable income for home-owning consumers;
  • For example, the UK had been raising interest rates until December 2007, in part to counter rising inflation. This resulted in a slowing housing market as consumers delayed buying until rates began to fall again;
  • Speculation about future interest rate rises can encourage consumers to spend immediately, rather than risk buying at a time of more financial difficulty. Interest rate meetings are closely covered in the media, keeping consumers aware of potential future trends. This is particularly true of major regional and global economies, such as the USA, Europe and Japan;
  • Conversely, speculation about future rate cuts can discourage consumer spending, reducing the potential for business profits. Consumers who believe that credit is going to be easier to access in the future will put off making major purchases until after rates go down.

Perceptions vs reality

Consumer perceptions of when is a good time to spend or save are sometimes opposed to economic reality:

  • For example, many consumers view times of high or rising inflation as a signal to save more, since inflation is reducing real wages and hence disposable income;
  • However, as well as the incentive to buy goods before they increase in price, it can also be a good time to access credit or take out loans. This is because inflation will erode the debt load, making credit cheaper in the medium term, even if interest rates do not change;
  • In addition, times of economic slowdown are the best in which to spend, since increased consumer spending would stimulate the domestic economy and speed the return to economic prosperity;
  • Since consumer spending figures are not released until some months later – for example, on a quarterly basis – perceptions are also shaped by consumer confidence surveys. Although not as exact as specific spending figures, these give an indication of whether confidence is trending upwards or downwards and therefore whether spending is likely to rise or fall. This in turn can shape business policy. For example, declining consumer confidence surveys in the UK in November and December 2007 indicated poor sales around the usually busy Christmas spending period. In response, many retail businesses began sales early in an effort to entice more consumers and increase sales;
  • Likewise, rising consumer confidence indicators in the USA around Thanksgiving weekend in November – a key shopping period – indicated that consumer spending could begin to pick up, indicating better than expected sales around the Christmas period.

At times, consumer perceptions of risk can prolong or exacerbate periods of economic slowdown that are depressing disposable incomes.

Future scenarios

The global economy is entering a period of turbulence in 2008, owing to a combination of high oil prices, a slowdown in the USA led by weakness in the housing sector, and rising commodity prices:

  • Steady demand, particularly from China, will keep oil prices high and maintain import costs for non-oil producers. In many countries this will result in rising prices, as governments are forced to remove or reduce subsidies for fuel prices. Taiwan, China, Indonesia and Nepal have already seen some price adjustment, which will reduce disposable consumer income and therefore future spending;
  • For net oil producers, this may result in improving consumer spending, as more money enters the economy. For example, Venezuela, Russia, and Nigeria will benefit from higher revenues, although high levels of social inequality in these countries mean that the benefits will only be felt by a limited proportion of the population, such as the middle and upper classes. However, higher government revenues mean that social assistance programmes will not be curtailed, as they might be in oil importing countries such as Nepal and Senegal. There are therefore few downside risks to consumer spending growth in oil producing countries;
  • This is producing a crossover period between prosperity and slowdown, with inflation and interest rates fluctuating accordingly. As such, some countries are raising interest rates to counter inflation (often imported), which will discourage consumer spending. Other countries are cutting interest rates to stimulate consumer spending and improve economic activity;
  • Of the world’s top ten largest economies, three have entered a downwards interest rate trend (USA, UK, Canada), one is increasing rates (China), while the remaining six are maintaining rates on hold in order to gauge more accurately risk in 2008 (Japan, Germany, France, Italy, Spain and India).
Interest rates in selected countries: December 2007

Source: National statistics.

This crossover period has the potential to increase consumer perceptions of risk, reducing consumer confidence and weighing on potential for consumer spending growth in 2008.