UK households start to save
Mon, Jul 13 2009, 13:01 GMT
by Lloyds TSB Financial Markets Economic Research Team
There is little doubt that 20 years of ever rising leverage is now over. The period of rising debt was characterised by an increase in the frequency, and intensity, of financial crisis, culminating in the worst collapse since the 1930s. Ever rising debt was not just a UK phenomenon but it, and the US, experienced the fastest growth in indebtedness during the last decade, see chart a, reflecting a widening gap between domestic savings and investment. So, critical to the resolution of the global financial crisis is a period of deleveraging - where households and companies pay back debt or, at least, peg borrowing growth below income growth. Since UK economic growth in the last decade has been boosted by increased borrowing, exemplified through the fast pace of growth in consumer spending, the trend pace of overall economic growth in the next decade will likely be significantly slower than in the last decade.
High household debt to hold back borrowing and spending
After a decade in which consumer spending has risen faster than any other category of economic growth, see chart c, the effect of lower leverage will be profound. In the next few years, we expect that consumer spending growth will be slower than that of overall economic growth. This is where the corporate sector could step in, despite it having a higher overall debt to gdp ratio than households, see chart b. The reasons were laid out in our last Economics Weekly, but key to company investment spending leading economic recovery in the UK is a continued weak exchange rate. To that extent, the recent strengthening of sterling, up 13% since its lows earlier this year, is not good news from the perspective of seeking to boost economic growth. But since consumer spending is the biggest component of the expenditure measure of gdp, its spending pattern is critical for the overall level of economic growth.
Households are cutting back on leverage…
With rising unemployment, UK consumers are beginning to spend less in the shops, so retail sales growth is now slowing sharply and recently moved into negative territory in year on year terms, see chart c. With greater uncertainty about job prospects, a still weak housing market, and a financial deficit (more borrowing than saving), UK households are raising their savings rate. Chart d shows that UK households are reducing their bank borrowing at a fairly rapid pace. Historically, UK consumers have run a financial surplus, and we assume that this returns in the year ahead. The consequence of that is the saving ratio, which fell to 3% in Q1 2009 from 4% in Q4 2008, will at least double in the next two years, see chart e. This will necessarily mean that consumer spending growth will remain in negative territory this year and next.
…and raising their saving ratio…
However, the news is not all bleak; a return to financial surplus and weaker growth in consumer spending will help to reduce the UK’s current account deficit. And if the pound remains competitive, the UK could experience a better export than import performance - although this may be due in the early stages to imports falling faster than exports. Nevertheless, the net effect would be to boost overall economic growth. As well, UK households have had a huge beneficial effect from the cuts in bank rate and by the fall in long term interest rates as inflation and inflation expectations fell back. This has sharply reduced interest payments, particularly for housing debt which is by far the largest component of household liabilities, see chart f.
…thereby acting to weaken economic growth for years to come
Weaker price inflation has also helped to boost household income growth, in spite of weakening employment income as unemployment rises. But this will not prevent consumer spending from falling this year and next. This is one reason why policy rates will likely stay low, inflation allowing (as it should as even with some scrapping a large output gap will persist for many years), until economic recovery looks entrenched. Any rise in interest rates will hit household disposable income, and put further downward pressure on spending and upward pressure on savings. The next two years promise to be tough ones for consumer spending and so for the rest of the economy, see chart g. However, as the economy stabilises and the pressure from rising unemployment eases, household spending should turn positive, possibly in 2011, albeit at or below income growth.
