In April we asked how sustainable is the UK’s appetite for credit? Data in the latest Bank of England’s Money and Credit publication suggest that such concerns are likely grow. It shows net lending (lending net of repayments) by monetary financial institutions (MFIs) to individuals in March 2016 was £9.3 billion, the highest monthly total since August 2007. This took net borrowing over the previous 12 months to £58.6 billion, the highest 12-month figure since September 2008.
The latest credit data raise fears about the impact on the financial well-being of individuals. The financial well-being of people, companies, banks and governments can have dramatic effects on economic activity. These were demonstrated vividly in the late 2000s when a downturn resulted from attempts by economic agents to improve their financial well-being. Retrenchment led to recession. Given the understandable concerns about financial distress we revisit our April blog.
Chart 1 shows the annual flow of lending extended to individuals, net of repayments. (Click here to download a PowerPoint of Chart 1.) The chart provides evidence of cycles both in secured lending and in consumer credit (unsecured lending).
The growth in net lending during the 2000s was stark as was the subsequent squeeze on lending that followed. During 2004, for example, annual net flows of lending from MFIs to individuals exceeded £130 billion, the equivalent of close on 10.5 per cent of annual GDP. Secured lending was buoyed by strong house price growth with UK house price inflation rising above 14 per cent. Nonetheless, consumer credit was very strong too equivalent to 1.8 per cent of GDP.
Net lending collapsed following the financial crisis. In the 12 months to March 2011 the flow of net lending amounted to just £3.56 billion, a mere 0.2 per cent of annual GDP. Furthermore, net consumer credit was now negative. In other words, repayments were exceeding new sums being extended by MFIs.
Clearly, as Chart 1 shows, net lending to individuals is again on the rise. This partly reflects a rebound in sections of the UK housing market. Net secured lending in March was £7.435 billion, the highest monthly figure since November 2007. Over the past 12 months net secured lending has amounted to £42.1 billion, the highest 12-month figure since October 2008.
Yet the growth of unsecured credit has been even more spectacular. In March net consumer credit was £1.88 billion (excluding debt extended by the Student Loans Company). This is the highest month figure since March 2005. It has taken the amount of net consumer credit extended to individuals over the past 12 months to £16.435 billion, the highest figure since December 2005.
Chart 2 shows the annual growth rate of both forms of net lending by MFIs. In essence, this mirrors the growth rate in the stocks of debt – though changes in debt stocks can also be affected by the writing off of debts. The chart captures the very strong rates of growth in net unsecured lending from MFIs. We are now witnessing the strongest annual rate of growth in consumer credit since November 2005. (Click here to download a PowerPoint of the chart.)
The growth in household borrowing, especially that in consumer credit, evidences the need for individuals to be mindful of their financial well-being. Given that these patterns are now becoming well-established you can expect to see considerable comment in the months ahead about our appetite for credit. Can such an appetite for borrowing be sustained without triggering a further balance sheet recession as experienced at the end of the 2000s?
Articles
Consumer credit rises at fastest pace for 11 years The Guardian, Hilary Osborne (29/4/16)
Debt bubble fears increase as consumer credit soars to 11-year high The Telegraph, Szu Ping Chan (29/4/16)
Fears of households over-stretching on borrowing as consumer credit grows The Scotsman, (29/4/16)
History repeating? Fears of another financial crisis as borrowing reaches 11-year high Sunday Express, Lana Clements (29/4/16)
The chart that shows we put more on our credit cards in March than in any month in 11 years Independent, Ben Chu (1/4/16)
Britain’s free market economy isn’t working The Guardian (13/1/16)
Data
Money and Credit – March 2016 Bank of England
Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England
Questions
- What does it mean if individuals are financially distressed?
- How would we measure the financial well-being of individuals and households?
- What actions might individuals take it they are financially distressed? What might the economic consequences be?
- How might uncertainty affect spending and saving by households?
- What measures can policymakers take to reduce the likelihood that flows of credit become too excessive?
- What is meant by a balance sheet recession?
- Explain the difference between secured debt and unsecured debt.
- Should we be more concerned about the growth of consumer credit than secured debt?
The latest Bank of England’s Money and Credit release shows net lending (lending net of repayments) by Monetary Financial Institutions (MFIs) to individuals in February was £4.9 billion. Although down on the £5.4 billion in January, it nonetheless means that over the last 12 months the flow of net lending amounted to £52.8 billion. This is the highest 12-month figure since October 2008.
The latest credit data raise concerns about levels of lending and their potential to again impact on the financial well-being of individuals, particularly in light of the falling proportion of income that households are saving. As we saw in UK growth fuelled by consumption as households again lose affection for their piggy banks the saving ratio fell to an historic low of 4.2 per cent for 2015.
An important factor affecting the financial well-being of individuals and households is the extent of their indebtedness. Flows of credit accumulate to become stocks of debt. Stocks of debt affect the extent to which household incomes becomes prey to debt servicing costs. Put simply, more and more income, all other things being equal, is needed for interest payments and capital repayments as debt stocks rise. Rising stocks of debt can also affect the ability of people to further fund borrowing, particularly if debt levels grow more quickly than asset values, such as the value of financial assets accumulated through saving. Consequently, the growth of debt can result in households incurring what is called balance sheet congestion with deteriorating financial well-being or increased financial stretch.
Chart 1 shows the stocks of debt acquired by individuals from MFIs, i.e. deposit-taking financial institutions. It shows both secured debt stocks (mortgage debt) and unsecured debt stocks (consumer credit). The scale of debt accumulation, particularly from the mid 1990s up to the financial crisis of the late 2000s is stark.
At the start of 1995 UK individuals had debts to MFIs of a little over £430 billion, the equivalent of roughly 55 per cent of annual GDP (Gross Domestic Product). By the autumn of 2008 this had hit £1.39 trillion, the equivalent of roughly 90 per cent of annual GDP. At both points around 85 per cent of the debt was secured debt, though around the start of the decade it had fallen back a little to around 80 per cent. (Click here to download a PowerPoint of Chart 1.)
The path of debt at the start of the 2010s is consistent with a story of consolidation. Both financially-distressed individuals and MFIs took steps to repair their balance sheets following the financial crisis. These steps, it is argued, are what resulted in a balance sheet recession. This saw the demand for and supply of additional credit wane. Consequently, as Chart 1 shows debt accumulation largely ceased.
More recently the indebtedness to MFIs of individuals has started to rise again. At the end of February 2014 the stock of debt was just shy of £1.4 trillion. By the end of February 2016 it had risen to £1.47 trillion (a little under 80 per cent of annual GDP). This is an increase of 4.7 per cent. Interestingly, the rise was largely driven by unsecured debt. It rose by 13.4 per cent from £159.4 billion to £180.7 billion. Despite the renewed buoyancy of the housing market, particularly in South East England, the stock of secured debt has risen by just 3.6 per cent from £1.24 trillion to £1.28 trillion.
Chart 2 shows the annual flow of lending extended to individuals, net of repayments. (Click here to download a PowerPoint of Chart 2.) The chart provides evidence of cycles both in secured lending and in consumer credit (unsecured lending).
The growth in net lending during the 2000s was stark as was the subsequent squeeze on lending that followed. During 2004, for example, annual net flows of lending from MFIs to individuals exceeded £130 billion, the equivalent of close on 10.5 per cent of annual GDP. Secured lending was buoyed by strong house price growth with UK house price inflation rising above 14 per cent. Nonetheless, consumer credit was very strong too equivalent to 1.8 per cent of GDP.
Net lending collapsed following the financial crisis. In the 12 months to March 2011 the flow of net lending amounted to just £3.56 billion, a mere 0.2 per cent of annual GDP. Furthermore, net consumer credit was now negative. In other words, repayments were exceeding new sums being extended by MFIs.
Clearly, as Chart 2 shows, we can see that net lending to individuals is again on the rise. As we noted earlier, part of this this reflects a rebound in parts of the UK housing market. It is perhaps worth noting that secured lending helps individuals to purchase housing and thereby acquire physical wealth. While secured lending can find its way to fuelling spending, for example, through the purchase of goods and services when people move into a new home, consumer credit more directly fuels spending and so aggregate demand. Furthermore, consumer credit is not matched on the balance sheets by an asset in the same way that secured credit is.
Chart 3 shows the annual growth rate of both forms of net lending by MFIs. In essence, this mirrors the growth rate in the stocks of debt though changes in the stocks of debt can also be affected by the writing off of debts. What the chart nicely shows is the strong rates of growth in net unsecured lending from MFIs. In fact, it is the strongest annual rate of growth since January 2006 (Click here to download a PowerPoint of the chart.)
The growth in consumer credit, the fall in the saving ratio and the growth in consumer spending point to a need for individuals to be mindful of their financial well-being. What is for sure, is that you can expect to see considerable comment in the months ahead about consumption, credit and income data. Fundamental to these discussions will be the sustainability of current lending patterns.
Articles
Consumer Lending Growth Highest Since 2005 Sky News, (31/3/16)
Britons raid savings to fund spending as economists warn recovery ‘built on sand’ Telegraph, Szu Ping Chan (31/3/16)
Household debt binge has no end in sight, says OBR Telegraph, Szu Ping Chan (17/3/16)
Surge in borrowing… as savings dwindle: Household savings are at an all-time low as families turn to cheap loans and credit cards Daily Mail, James Burton (1/4/16)
George Osborne banks on household debt time bomb to meet his Budget targets Mirror, Ben Glaze (29/3/16)
Britain’s free market economy isn’t working Guardian (13/1/16)
Data
Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England
Questions
- What does it mean if individuals are financially distressed?
- How would we measure the financial well-being of individuals and households?
- What actions might individuals take it they are financially distressed? What might the economic consequences be?
- How might uncertainty affect spending and saving by households?
- What measures can policymakers take to reduce the likelihood that flows of credit become too excessive?
- What is meant by a balance sheet recession?
- Explain the difference between secured debt and unsecured debt.
- Should we be more concerned about the growth of consumer credit than secured debt?
The latest data in the Quarterly National Accounts show that UK households in 2015 spent £1.152 trillion, the equivalent of 62 per cent of the country’s Gross Domestic Product (GDP). In real terms, household spending rose by 2.8 per cent in 2015 in excess of the 2.3 per cent growth observed in GDP. In the final quarter of 2015 real household spending rose by 0.6 per – the same rate of growth as that recorded for the UK economy. This was the tenth consecutive quarter of positive consumption growth and the twelfth of economic growth.
It is the consistent growth seen over the recent past in real household spending that marks it out from the other components of aggregate demand. Consequently, household spending remains the bedrock of UK growth.
Chart 1 helps to evidence the close relationship between consumption and economic growth. It picks out nicely the stark turnaround both in economic growth and consumer spending following the financial crisis. Over the period from 2008 Q1 to 2011 Q2, real consumer spending typically fell by 0.4 per cent each quarter. This weakness in consumption was mirrored by economic growth. Real GDP contracted over this period by an average of 0.2 per cent each quarter. (Click here to download a PowerPoint of the chart.)
Since 2011 Q3 real consumption growth has averaged 0.6 per cent per quarter – the rate at which consumption grew in 2015 Q4 – while, real GDP growth has averaged 0.5 per cent per quarter. Over this same period the real disposable income (post-tax income) of the combined household and NPISH (non-profit institutions serving households), has typically grown by 0.4 per cent per quarter. (NPISHs are charities and voluntary organisations.)
The strength of consumption relative to income is evidenced by the decline in the saving ratio as can be observed in Chart 2. The ratio captures the percentage of disposable income that households (and NPISHs) choose to save. In 2010 Q3 the proportion of income saved hit 11.9 per cent having been as low as 4.5 per cent in 2008 Q1. By 2015 Q4 the saving ratio had fallen to 3.8 per cent, the lowest value since the series began in 1963 Q1. (Click here to download a PowerPoint.)
The historic low in the saving ratio in the final quarter of 2015 reflects the strength of consumption alongside a sharp fall in real disposable income of 0.6 per cent in the quarter. However, the bigger picture shows a marked downward trend in the saving ratio over the period from 2012.
When seen in a more historic context the latest numbers taken on even greater significance. Chart 3 shows the annual saving ratio since 1963. From it we can see that the 2015 value of 4.2 was the first year when the ratio fell below 5 per cent. With 2014 being the previous historic low, there must be some concern that UK consumption growth is not being underpinned by income growth. (Click here to download a PowerPoint.)
Of course, consumption theory places great emphasis on expected future income in determining current spending. To some extent it may be argued that households were liquidity-constrained following the financial crisis. They were unable to borrow to support spending and, as time moved on, to borrow against the expectation of stronger income growth in the future. This would have depressed consumption growth. But, there may also have been a self-imposed liquidity constraint as the financial crisis unfolded. Heightened uncertainty may have led households to be more prudent and divert resources to saving. Such precautionary saving would tend to boost the saving ratio and so may be a factor in the sharp rise we observed in the ratio.
The easing of credit constraints as we headed through the early 2010s allied with stronger economic growth may help to explain the strength of the recovery in consumption growth. However, it is the extent and, in particular, the duration of this strong consumption growth that is fuelling a debate over its sustainability. The current uncertainty around future income growth and the need for households to be mindful of the indebtedness built up prior to the financial crisis point to households needing to retain a degree of caution. Consequently, the debates around the financial well-being of households and the need to rebalance the UK economy away from consumer spending are likely to be further intensified by the latest consumption and saving data.
Data
All data related to Quarterly National Accounts: Quarter 4 (Oct to Dec) 2015 Office for National Statistics
Office for National Statistics Office for National Statistics
Articles
Britons raid savings to fund spending as economists warn recovery ‘built on sand’ Telegraph, Szu Ping Chan (31/3/16)
UK Growth Higher But Deficit Hits New Record Sky News, (31/3/16)
Britain is a nation that has forgotten how to save Telegraph, Jeremy Warner (31/3/16)
A vulnerable economy: the true cost of Britain’s current account deficit Guardian, Larry Elliott (31/3/16)
U.K. Manufacturing ‘In the Doldrums’ Leaves Growth Lopsided Bloomberg, Emma Charlton (1/4/16)
Pound drops as UK manufacturing languishes in the doldrums Telegraph, Szu Ping Chan (1/4/16)
Questions
- Why is the distinction between nominal and real growth an important one when looking at many macroeconomic variables.
- Examine the argument that the historic low saving ratio in the UK is a cause for concern.
- What factors might we expect to impact on the saving ratio?
- To what extent do you think the current growth in consumer spending is sustainable?
- How important are expectations in determining consumer behaviour?
- Explain what you understand by consumption smoothing.
- Why would we would typically expect consumption growth to be less variable than that in disposable income?
- Why might consumption sometimes be observed to be less sensitive or more sensitive to income changes?
- What factors might cause households to be liquidity constrained?
- What is precautionary saving? What might affect its perceived importance among households?
Interest rates in the UK have been at a record low since 2009, recorded at just 0.5%. In July, the forward guidance from Mark Carney seemed to indicate that a rate rise would be likely towards the start of 2016. However, with the recovery of the British economy slowing, together with continuing problems in Europe and slowdowns in China, a rate rise has become less likely. Forward guidance hasn’t been particularly ‘guiding’, as a rate rise now seems most likely well into 2016 or even in 2017 and this is still very speculative.
Interest rates are a key tool of monetary policy and one of the government’s demand management policies. Low interest rates have remained in the UK as a means of stimulating economic growth, via influencing aggregate demand. Interest rates affect many of the components of aggregate demand, such as consumption – through affecting the incentive to save and spend and by affecting mortgage rates and disposable income. They affect investment by influencing the cost of borrowing and net exports through changing the exchange rate and hence the competitiveness of exports.
Low interest rates therefore help to boost all components of aggregate demand and this then should stimulate economic growth. While they have helped to do their job, circumstances across the global economy have acted in the opposite direction and so their effectiveness has been reduced.
Although the latest news on interest rates may suggest some worrying times for the UK, the information contained in the Bank of England’s Inflation Report isn’t all bad. Despite its predictions that the growth rate of the world economy will slow and inflation will remain weak, the predictions from August remain largely the same. The suggestion that interest rates will remain at 0.5% and that any increases are likely to be at a slow pace will flatten the yield curve, and, with predictions that inflation will remain weak, there will be few concerns that continuing low rates will cause inflationary pressures in the coming months. Mark Carney said:
“The lower path for Bank Rate implied by market yields would provide more than adequate support to domestic demand to bring inflation to target even in the face of global weakness.”
However, there are many critics of keeping interest rates down, both in the UK and the USA, in particular because of the implications for asset prices, in particular the housing market and for the growth in borrowing and hence credit debt. The Institute of Directors Chief Economist, James Sproute said:
“There is genuine apprehension over asset prices, the misallocation of capital and consumer debt…Borrowing is comfortably below the unsustainable pre-crisis levels, but with debt once against rising there is a need for vigilance…The question is, will the Bank look back on this unprecedented period of extraordinary monetary policy and wish they had acted sooner? The path of inaction may seem easier today, but maintaining rates this low, for this long, could prove a much riskier decision tomorrow.”
hanges in the strength of the global economy will certainly have a role to play in forming the opinions of the Monetary Policy Committee and it will also be a key event when the Federal Reserve pushes up its interest rates. This is certainly an area to keep watching, as it’s not a question of if rates will rise, but when.
Articles
Bank of England dampens prospects of early UK rate rise BBC News (5/11/15)
Bank of England Governor gets his forward guidance on interest rates wrong Independent, Ben Chu (6/11/15)
Interest rates set to remain at rock-bottom right through 2016 as Bank of England cuts UK growth and inflation forecasts This is Money, Adrian Lowery (5/11/15)
Pound slides as Bank of England suggests interest rates will stay low for longer – as it happened 5 November 2015 The Telegraph, Peter Spence (5/11/15)
UK’s record low interest rates should be raised next Februrary says NIESE The Telegraph, Szu Ping Chan (4/11/15)
Fresh signs of slowdown will force interest rates rise to be put on hold The Guardian, Katie Allen (2/11/15)
The perils of keeping interest rates so low The Telegraph, Andrew Sentence (6/11/15)
Time to ask why we are still in the era of ultra-low rates Financial Times, Chris Giles (4/11/15)
No interest rate rise until 2017: Joy for homeowners as Bank of England delays hike in mortgage costs again Mail Online, Matt Chorley (5/11/15)
Pound tumbles after Carney warns its strength threatens recovery Bloomberg, Lucy Meakin (5/11/15)
Is Carney hurt by wrong rate steer? BBC News, Robert Peston (5/11/15)
Data and Reports
Inflation Report Bank of England (August 2015)
Inflation Report Bank of England (November 2015)
Historical Fan Chart Data Bank of England (2015)
Questions
- Use and AD/AS diagram, explain how low interest rates affect the key components of aggregate demand and in turn how this will affect economic growth.
- What is meant by the ‘yield curve’? How has it been affected by the latest release from the Monetary Policy Committee?
- Why has the value of the pound been affected following the decision to keep interest rates at 0.5%?
- How has the sterling exchange rate changed and how might this affect UK exports?
- What are the main concerns expressed by those who think that there is a danger from keeping interest rates low for too long?
- Why is the outlook of the global economy so important for the direction of interest rate changes?
There’s some good news and some bad news about the UK economy. The good news is that there are signs that the recovery is gathering momentum; the ‘green shoots’ are growing bigger. The bad news is that it’s the ‘wrong type of growth’!
One of the main underlying problems of the 2008 financial crisis was that household debt had been increasing to unsustainable levels, egged on by banks only too willing to lend, whether as personal loans, on credit cards or through mortgages. When the recession hit, many people sought to reduce their debts by cutting back on spending. This further fuelled the recession.
What the government and most economists hoped was that there would be some rebalancing of the economy, with less reliance on consumer spending to drive economic growth. Instead it was hoped that growth would be driven by a rise in investment and exports. Indeed, the 25% depreciation of sterling exchange between 2007 and 2009 was seen as a major advantage as this would boost the demand for exports and encourage firms to invest in the export sector.
But things haven’t turned out the way people hoped. The recession (or lack of growth) has been much deeper and more prolonged than previous downturns in the economy. Today, real GDP per head is more than 7% below the level in 2007 and many people have seen much bigger declines in their living standards.
But also, despite the austerity policies, the economy has not been ‘rebalanced’ towards exports and investment. Exports are 3% lower than in 2006 (although they did grow between 2009 Q2 and 2011 Q1, but have since stagnated). And investment is 27% lower than in 2006. Household consumption, however, has grown by about 2% and general government consumption by around 9% since 2006. The chart shows the figures, based on 2006 Q1 = 100.
(Click here for a PowerPoint of the chart.)
And recent evidence is that consumption is beginning to grow faster – not because of rising household incomes, but because of falling saving rates. In 2008, the household saving ratio had fallen to nearly 0% (i.e. households were on average saving about the same as they were borrowing). Then the saving ratio rose dramatically as people reined in their spending. Between 2009 and 2012, the ratio hovered around 7%. But in the first quarter of 2013, it had fallen to 4.2%
So the good news is that aggregate demand is rising, boosting economic growth. But the bad news is that, at least for the time being, this growth is being driven by a rise in household borrowing and a fall in household saving. The videos and articles consider whether this is, however, still good news on balance.
Webcasts
Britain’s imbalanced economy The Economist, Zanny Minton Beddoes and Richard Davies (4/7/13)
Britain’s Export Drought: an enduring disappointment The Economist, Andrew Palmer and Richard Davies (9/2/13)
‘Green shoots’ of economic recovery in Rugby BBC News, Paul Mason (12/6/13)
Articles
Is the UK economy seeing the ‘wrong kind’ of green shoots? BBC News, Stephanie Flanders (3/7/13)
The export drought: Better out than in The Economist (9/2/13)
Exports and the economy: Made in Britain The Economist (21/1/12)
The economy: On a wing and a credit card The Economist (6/7/13)
Unbalanced and unsustainable – this is the wrong kind of growth The Telegraph, Jeremy Warner (8/7/13)
The UK economy’s looking up – but no one’s told manufacturers The Guardian, Heather Stewart (10/7/13)
Data
Quarterly National Accounts, Q1 2013 (27/6/13)
Forecasts for the UK economy: a comparison of independent forecasts HM Treasury (June 2013)
ISM Manufacturing Report on Business® PMI History Institute for Supply Management
Questions
- What are forecasters expecting to happen to economic growth in the coming months? Why?
- What factors determine investment? Why has it fallen so substantially in the UK?
- Explain what is meant by the ‘accelerator’. Is the rise in consumption likely to lead to an accelerator effect and, if so, what will determine the size of this effect?
- Why have exports not grown more rapidly despite the depreciation of sterling after 2007?
- What will determine the rate of potential economic growth in the UK economy? How will a rise in real GDP driven by a rise in consumption impact on potential GDP and potential economic growth?
- What supply-side policies would you recommend, and why, in order to increase potential economic growth?
