Despite historically low interest rates on deposits, Australian consumers are saving, not spending.

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This might be good news for banks looking for cheap ways to fund new lending, but it’s a negative for the Federal Government as it tries to sell the idea that it is laying the fundamentals for economic growth.

Prime Minister Tony Abbott yesterday said the government was focused on supporting job generation by providing incentives for small businesses, including new tax breaks from July 1.

The problem, however, is that the demand for business credit is anaemic and it is not likely to improve until there are signs that consumer confidence is recovering.

As it prepares its next budget, the government needs to consider incentives that might encourage Australian consumers to start spending again.

The Reserve Bank, according to pricing benchmarks in the local bond market, is set to take a step in that direction today by cutting official interest rates.

Consumer sentiment sags

Consumer confidence, as measured by Westpac’s Consumer Sentiment Index, slumped sharply in December and this observation has since been borne out in a string of profit warnings issued by ASX-listed retailers in recent weeks.

The latest retailer to hit the skids is adventure apparel retailer, Kathmandu, which suffered a 25 per cent fall in the value of its shares on Monday after it warned investors it would not meet its profit forecasts.

JB Hi Fi and The Reject Shop also failed to meet profit expectations for the December half.

Many retailers were hopeful late last year that falling petrol prices during the Christmas shopping season would stoke a year-end spending spree.

That did not materialise.

Instead, most Australian households banked their spare cash.

According to Bank of America’s chief economist, Saul Eslake, consumer confidence is struggling to recover following the government’s maiden budget.

“I think the public reacted viscerally to the Federal Budget,” he said.

“Consumers have become a lot more pessimistic about the long term health of the economy.

“In January, consumer sentiment didn’t rebound much, which was surprising in light of the fall in petrol prices.”

Record growth in bank deposits in December

The latest banking statistics published by the Australian Prudential Regulation Authority show that consumers funnelled more than $13.3 billion into their bank accounts in December.

This is the highest amount of monthly savings recorded by domestic households since the major banks were flooded with deposits during the global financial crisis in 2008.

Most of the growth in household deposits is attributable to new savings by consumers because interest rate returns have fallen to historically low levels.

Even though interest rates on deposits were up to 1.5 per cent higher a year ago, consumer deposits held by local banks grew by only $8.74 billion in December 2013.

Reserve bank poised to cut rates

Westpac chief economist Bill Evans was the first of the forecasters from the major banks to tip a rate cut by the Reserve Bank at the February board meeting.

Evans made the forecast on December 4, citing flagging consumer sentiment, falling real national incomes and lower economic growth as factors likely to cause the central bank to loosen monetary policy.

Last week, Mr Evans noted that bond traders had factored in a 65 per cent chance of an official cut since he first made his rate prediction in early December.

“The RBA does not have a history of surprising markets,” Mr Evans said.

“Market pricing at the time(on December 4) gave only a 25% probability to the cut.

“That has now lifted to a respectable 65 per cent; indeed, arguably a level that would pressure the Bank to explain itself if it chose not to move.”