06 July 2017
Saving too little, spending too much
The stark facts regarding household finances
by Frank O’Nomics
It’s not exactly Mr. Micawber’s recipe for happiness. Recent increases in the UK’s cost of living are having a significant impact on both household savings and levels of debt. The pick up in inflation at a time when wage growth has been barely discernable has meant that households have a rapidly declining amount of money to put into savings. For some this has reached a point where they are increasing their levels of borrowing, pushing consumer credit levels to a point where the Bank of England, and The Prudential Regulation Authority, are starting to get worried. These are factors that need careful consideration. There are a number of scenarios that could play out, each of which has potentially significant consequences for our economy.
So how bad is the situation? From a savings point of view, the savings rate fell from 3.3% in Q4 of last year, to 1.7% in Q1 of this year. To put it in context, this data series has been running since 1963 and has never been lower. Inflation has meant that household real incomes have been declining for three successive quarters, which is the longest stretch for forty years. There seems little prospect of this being turned around. The cabinet may be split on taking off the 1% cap on public sector pay growth. The strength of public outcry might mean that a response is inevitable but, even if this was to happen, public sector pay is only a small part of the problem. Private sector pay growth, while it may have improved more rapidly in the last few years, is no better than the public sector when looked at over a 10 year period, and so household saving capacity here is similarly constrained (and arguably more so given that those in the private sector do not benefit from the effective savings accrued into some generous public sector pension schemes).
On the spending side the constraints on household finances is starting to have an effect, with the latest levels of consumer spending growth around half the levels of the previous quarter. However, what is being spent does still seem to be adding to household debt levels. Consumer lending is growing at a rate of around 10% per annum, with credit card debt, overdrafts and personal loans currently outstanding totaling £90.2 billion. This is dwarfed by the £838 billion of mortgage loans, but is significant because it is on much higher interest rates, is much shorter term and is unsecured (you can always sell your property to pay your debts, but you are unlikely to get much for that second hand cashmere jumper). Write offs in consumer credit run at around 10 times those in mortgage lending. Recent research by Liberum on the motor vehicle lender Moneybarn highlights the constraints of these levels of debt. They calculate that the average Moneybarn customer spends 33% of their income on rent, 23% on their car loan and 10% on credit card repayments. That leaves very little money for food and energy, and effectively nothing for savings. Finance deals for car purchases are a major factor in the increase in debt. With 90% of new cars funded by borrowing, the car finance market now stands at £40 billion.
The trends in both falling savings and rising borrowing look set to continue, but are unlikely to be allowed to do so without response from households themselves or the government. People are likely to reduce their spending further and, while they may not be able to pay off much of their debts, that should reduce the rate of build up. For the authorities, beyond increasing public sector pay, there is growing pressure for the Bank of England to start to constrain credit growth. Measures taken after the Brexit vote, to reduce the capital buffer that banks are forced to hold against their lending exposure, seem likely to be reversed, and the Bank of England’s Term Funding Scheme is being criticised for causing excessive competition between banks. These factors together have helped to provide £106 billion in cheap liquidity and removing them, and so increasing the cost of funding for banks, would lead to banks increasing their borrowing rates to protect their margins. Such moves are more targeted than a base rate rise, which might be seen as premature given the state of economic growth. Similarly, there is likely to be an increase in the “leverage ratio” of capital held vs. exposures at banks from 3% to 3.25%, and The Financial Policy Committee is asking banks to stress test borrowers’ ability to repay loans at 3% above the standard variable rate. In short, credit is going to be harder to come by and more expensive.
What about interest rates overall? The vulnerability of the household sector may make the Bank reluctant to raise base rates for fear of triggering a crisis – far better to wean them off debt by restricting it. However, they cannot ignore the growth in inflation, the containment of which remains the central part of their remit. The key element may be the performance of the corporate sector, where an improvement in business investment (driven by cheap money) and service sector output points to some strength. If this continues rates will rise (Governor Carney said as much last week) – possibly as early as next month. If so we will at least be able to take some solace in earning more on the little savings that we are able to generate.
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