Consumer Credit Worries Suggest Spending Decline

GALLUP NEWS SERVICE

PRINCETON, NJ -- St. Louis Federal Reserve Bank President William Poole noted last Thursday that the biggest unknown for the economy is whether inflation pressures would prove temporary. He went on to say that if monetary policymakers see a more fundamental inflation problem, then the Fed will react "more vigorously." This follows his comments of the previous week, in which he noted that companies seem to be gaining pricing power -- the ability to raise prices. Of course, Poole's comments simply reinforce the Fed's reference to its inflation fears at its March meeting.

While the Fed remains focused on inflation, the new Experian/Gallup Personal Credit Index shows a sharp drop in consumers' optimism about their personal credit situations. Combined with the recent decline in Gallup's consumer confidence data as gas prices at the pump have surged, this drop in consumers' perceptions about their credit situations raises substantial doubts about the future of consumer spending.

Looking ahead, the key question seems to be whether the biggest danger to the future of the U.S. economy is inflation or, alternatively, a collapse of consumer spending. Right now, Gallup's economic data suggest that a collapse of consumer spending is a much higher probability than many economists within and outside of the Fed seem willing to acknowledge.

Optimism About Credit Takes a Plunge

Consumers' optimism about their personal credit situations fell sharply in April, declining 18 points to 82 from the baseline of 100 established in March. The decline was most pronounced in the Future Situation Index, which declined 13 points -- from 59 to 46. Compared to March, consumers showed less confidence in their ability to continue to make their monthly payments, less optimism that they will be able to borrow in the future if they need to do so, and a reduced likelihood that they will be able to pay down their debt.

Consumers' assessments of their current credit situations also declined, as the Present Situation Index declined by 5 points -- from 41 in March to 36 in April.

Younger Consumers Show Biggest Decline

By age, the biggest drop in optimism about personal credit situations occurred among consumers aged 18 to 29. The Personal Credit Index for this group fell 45 points, from 86 in March to 41 in April. The next-largest decline by age was in the 30- to 49-year-old group, whose Index dropped 21 points. The Personal Credit Index for 50- to 64-year-olds fell 9 points, while the Index for those aged 65 or older increased 2 points.

Lower-Income Consumers Also Show Large Decline

The Personal Credit Index for consumers with annual incomes of less than $40,000 a year declined by more than half -- going from 44 in March to 18 in April. The Index for those earning $75,000 or more annually also declined by 26 points in April, but at a much higher level -- dropping from 171 to 145. There was no change in the Index for consumers earning at least $40,000 but less than $75,000 annually.

Consumer Economic Expectations Plunge

According to a new Gallup Poll, conducted April 4-7, only 35% of consumers say current economic conditions in the country as a whole are "getting better," compared with 56% who say they are "getting worse." This difference of –21 percentage points is nearly as large as the –26 points recorded at the end of March. More importantly, it is twice the difference of –9 percentage points recorded in Gallup's March 7-10 poll, in which 41% said economic conditions were getting better and 50% said they were getting worse. Gallup's late March and early April poll results show that consumer expectations about the economy's future direction are the most negative they have been since the Iraq war began, in March 2003.

Consumer Spending Intentions Decline

Consumer spending intentions have declined significantly in April, as 24% of consumers say they intend to increase their spending over the next six months while 25% intend to decrease spending. This difference of –1 percentage point is a sharp drop from +12 percentage points in March and +6 points in February. Consumer spending intentions are now back to where they were in January, when there was a difference of –2 points between the percentage of consumers planning to increase spending and the percentage planning to decrease spending.

Will Consumer Spending Take a Plunge?

Gallup's attitudinal economic measures show consumer confidence tumbling as consumers have experienced record prices at the gas pump, increasing interest rates, stagnant wages, and slower-than-expected job growth. Investor optimism has also declined recently. And now, it appears consumers are becoming much less positive about their personal credit situations.

To this point, consumers have continued to spend even as their overall confidence in the economy's direction has declined. They have been able to do this in part by adding to their debt. In this context, consumers' growing concerns about their ability to make their future monthly payments, and borrow if the need arises, create a new threat to consumer spending. If consumers decide to slow their credit use, consumer spending on items other than food and energy may decline significantly in the months ahead.

Recently, a number of major retailers reported lower profits and slower-than-expected sales in March. One of their explanations to Wall Street was to blame their troubles on bad weather. In sharp contrast, Gallup's economic data suggest that the real cause may be a major decline in consumers' perceptions of their own personal credit situations.

Consumer credit perceptions declined most sharply among those under 50 and those having incomes of less than $40,000 annually. As a result, the consumer pullback is likely to be most pronounced at retailers serving these consumers. For example, on Saturday, Wal-Mart forecast that its same-store sales would increase 2% in April after climbing 4.3% in March. More importantly from an earnings perspective, the company noted a shift to food sales and away from the company's more profitable general-merchandise sales items.

If the economy is at a significant turning point in terms of consumer spending and credit growth, then economists who began lowering their growth forecasts for the second half of 2005 (according to the most recent Bloomberg survey) may have to repeat the process in a couple of months. Of greater importance, the Fed may need to begin rethinking the intensity of its focus on inflation, and give increased attention to the growing weakness in consumer confidence. At the same time, business executives may want to begin contingency planning for a much weaker economy in the second half of this year than has been generally expected.

Survey Methods

Results for the Experian/Gallup Personal Credit Index are based on telephone interviews with 1,010 national adults, aged 18 and older, conducted March 14-20, 2005. For results based on this sample, one can say with 95% confidence that the maximum margin of sampling error is ±3 percentage points.

Other results are based on telephone interviews with 1,010 national adults, aged 18 and older, conducted April 4-7, 2005. For results based on the total sample of national adults, one can say with 95% confidence that the maximum margin of sampling error is ±3 percentage points.

In addition to sampling error, question wording and practical difficulties in conducting surveys can introduce error or bias into the findings of public opinion polls.