Should we be worried about households’ finances?

August 02, 2018

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by Mike Jakeman Senior Economist

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Data from the Office for National Statistics (ONS) has showed that British households spent an average of £900 more than they received in 2017. This means they had to either take out bank loans or dip into their savings. Indications are that they did both. The value of loans taken out in 2017 rose to almost £80bn, its highest level since before the global financial crisis. Meanwhile, the household saving rate continued its recent decline, dropping to less than 2.5%, from 6% in 2015. (Rather than the headline saving rate, we prefer to look at an adjusted savings rate, which excludes net equity in pension funds. The adjusted rate tends to move in tandem with the headline rate, but is lower.) So far in 2018, the saving rate has remained well below its long-term average.  Should we be worried about these trends?

The answer has a lot to do with your view of monetary policy. The ONS rightly argues that consumers have responded to the cues sent out by the Bank of England. Interest rates have been very low since the crisis, and, without any inducement to save, they have chosen to spend a higher and higher proportion of their income. It is logical that the saving rate should be much lower when the base rate is 0.5% than when it was above 10%.

The central bank, therefore, has a significant role to play in what happens next. Here are two alternative scenarios based on research from our UK Economic Outlook report published in March. In the first, the Bank of England keeps interest rates as low as it can, citing concerns about the sustainability of economic growth and weakening inflation. Without the threat of more expensive mortgages, house prices continue to rise. Along with the record-high level of employment, these factors contribute to a wealth effect that keeps consumers spending. The adjusted saving ratio continues to fall and by 2020 turns negative. Overall debt levels continue to rise, but, with borrowing still cheap, there is no imminent threat of a reckoning.

In the second, the central bank believes it needs to build its resilience ahead of the next downturn and is confident enough in future growth to raise interest rates regularly. Fearing the unfamiliar sensation of more expensive debt repayments and buoyed by the prospect of higher returns from banks, consumers hold back on discretionary spending and squirrel away more of their income. With growth in house prices also much slower than in the recent past, the savings rate creeps up to 2.5% by 2020.

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But our main scenario takes a middle view. The Bank of England is likely to find its rate-raising capabilities constrained by uncertainty over post-Brexit policy. Although lower rates for longer would seem to encourage further household spending, confidence will be tempered by tepid growth in house prices. Sterling’s weakness will keep imported inflation elevated. Combined with an absence of concerted wage pressures, this will ensure real wage growth is moderate. Taken together, we expect the saving rate to edge down as far as 1.1% by 2020.

This scenario would have very different implications for households depending on their wealth. According to the ONS, the disposable income of the wealthiest decile was more than twice their expenditure in 2017. But for the poorest two deciles, their expenditure exceeded their income by 60% and 15% respectively. Each tightening of monetary policy would make borrowing to pay bills more expensive, while higher imported inflation would make some day-to-day essentials less affordable—unless these developments were accompanied by a larger increase in wages. Without higher incomes, a highly unusual occurrence in the ONS data could become a trend.

by Mike Jakeman Senior Economist

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