The credit crisis has resulted in less credit being made available for households and companies…
The credit crisis is still in full swing; in fact, it is worse now than when it first started in Q3 of last year. Credit spreads have widened out and interbank spreads are the widest that they have been at any time in the last 12 months. But our focus in this weekly is on the fact that with credit conditions tightening - a higher cost of borrowing and less credit being made available - we should be seeing a significant reduction in leverage by households and companies by now. But the data do not yet show that this is occurring; although debt accumulation is slowing it is still taking place. Given current events in financial markets, is it just a matter a time before it slows more sharply? We look at some evidence of where we are currently in the analysis that follows.
…but UK households are still accumulating debt faster than they are growing income…
UK households have accumulated a vast amount of debt since 1981, but this accelerated particularly sharply from about 1997 onwards, see chart a. During this period there was a dramatic fall in price inflation and so sharp cuts in interest rates, which made it easier to obtain credit. But there was also deregulation and a surge in the supply of credit, which increased the ability of households to get access to loans. Also, employment reached a record high and unemployment fell to a 35 year low as UK economic growth averaged 2.9%, adding to the fast pace of growth of loans.
We think that a combination of the credit crisis and slower economic growth will result in weaker growth in employment and a stalling of the 10 year falling unemployment trend over the next few years. This will result in a flattening in debt accumulation in the UK over the period to 2013, see chart a. But for that to happen, growth in loans relative to growth in incomes must slow so that loan growth is at least in line with income growth.
At present, as charts b and c show, although the credit crisis has meant that loans are less available for mortgages and for unsecured credit, there has only been a mild slowdown in the rate of borrowing of UK households. Indeed, looking at unsecured loan growth, it has accelerated. This may be a bad sign if it suggests increasing use of this form of credit to pay off debt on secured loans. Only time will tell, as we should see higher default rates and ultimately a sharp fall in this form of borrowing if that is the case. In the meantime, however, it is clear that the sort of loan slowdown that one would expect from the credit crisis is not yet significantly underway.
The same applies to corporate loan growth, see chart e, where profit growth is less than loan growth, implying a rise in the level of indebtedness of non-financial companies to lenders. This trend may, of course, be good news for the economy as it implies that the negative feedback loop from a cutting of loans to a cutting of spending by borrowers is not kicking in as much as many fear, at least not yet. But it could be bad news if the economy enters a deep recession, as debt defaults will likely rise to unprecedented levels.
…and this is leading to a further rise in the UK's debt burden though we think this trend will flatten in the years
ahead as the economy slows and less credit availability bites Looking at growth in borrowing by households, which amounted to about £1.4 trillion at end July 2008, currently accounting for some 170% of annual income, it is still rising well in excess of growth in income, see chart f. Indeed, breaking this total down into mortgage borrowing growth and unsecured borrowing growth shows that both categories are rising faster than income, meaning that the household debt burden as a share of income is still rising. However, for both categories of household debt the pace of growth is slowing, see chart g, and has slowed fastest for unsecured loans than for mortgages (unsecured loan growth has picked up in the past year). This trend needs to continue in order for the debt to income ratio to stabilise: in other words, debt cannot rise faster than income. There is a possibility that borrowing growth could fall below income growth if the credit crisis really bites and if households take fright at rising unemployment as the economy slows, and so increase their saving rate. Our central view, at present, is that a combination of this occurs in the years ahead and household borrowing and income growth balance for the first time in well over 20 years. This will show up as a flattening in debt to income ratios, albeit at a high level, see chart a.
As said at the start, the evidence would suggest that loan growth in the UK (company and household) is still faster than income growth so the adjustment to a more restrictive supply of credit - at a higher cost, and by fewer lenders - does not yet appear to be impacting borrowers as much as one would have thought one year into the credit crisis. However, it may just be a matter of time and, as the economy weakens, a slowdown in borrowing growth to a more sustainable pace becomes ever more likely.