Consumer Apathy: Next Threat to Australian Economy?

Brendon Thorne | Bloomberg | Getty Images

On top of a slowdown in Australia's lucrative mining sector, consumer sentiment in the country appears to have deteriorated sharply, posing a challenge to the central bank which cut interest rates to a record low earlier this month.

The Westpac-Melbourne Institute's index of consumer sentiment fell 7 percent month on month in May accelerating from the 5.1 percent decline in April. The poll of 1,200 people was conducted between May 13 and 18.

"The latest reading of consumer sentiment was something of a cold shower and wake-up call on the state of the consumer mindset," David de Garis, senior economist at National Australia Bank wrote in a report, noting that sentiment is now below the long term average.

A sub index measuring expectations for the economy over the next 12 months fell the most rapidly, down 13.4 percent from the previous month. While an index measuring perceptions of current conditions declined by 3.9 percent.

"This is suggestive that the tempo of the economy on the ground, as perceived by householders, has slowed but has been overshadowed by increasing worry about the outlook," de Garis said.

A major dampener on consumer sentiment has been the federal budget unveiled on May 14, said economists - in which the government delayed a long-promised return to a budget surplus and took away a range of benefits to middle-income families - alongside the swift fall in the Australian dollar. The Aussie has depreciated almost 5 percent against the U.S. dollar over the past month.

(Read More: Australia Delays Promised Budget Surplus as Election Looms)

The slowdown in spending poses a downside risk to the country's growth outlook, de Garis said, adding that the response of consumers to the Reserve Bank of Australia's (RBA) rate cut does not appear encouraging.

The RBA has slashed interest rates 200 basis points since late 2011 to boost the economy as mining investment peaks.

(Read More: Reserve Bank of Australia Cuts Rates to Record Low)

"For the RBA, this is a clear indication that consumer sentiment has taken a backward step. As the consumer has been one hopeful avenue of filling some of the gap left by the slowing pace of mining activity and spending, this is an issue for the RBA," de Garis said.

April retail sales data, due out on June 3, will be an important indicator to watch ahead of the central bank's next meeting on June 4, said economists.

At the moment, the market is pricing in less than a 20 percent chance of another interest rate cut next month.

"Today's [Wednesday's] consumer sentiment reading now makes that pricing a little light," he said.