News last week of a collapse in the UK savings ratio and a surge in consumer borrowing suggest that the consumer party may be getting out of hand.
Perhaps we shouldn't be too surprised. Following the financial crisis the Bank of England slashed interest rates and printed money to kick start the economy. Consumers have responded in text book fashion.
The latest credit numbers testify to the heady effects of cheap money and financial innovation on borrowing. A rising tide of on-line and contactless transactions and a new form of motor financing, Personal Contract Purchases (PCPs), offer new opportunities to borrow. In the motor industry PCPs have supplanted traditional credit arrangements and now account for over 80% of all new car purchases.
The fall in the savings ratio, to just 1.7%, the lowest level since 1963, is pretty dramatic. As recently as early 2016 the ratio stood at 6.1% and over the last 54 years it has averaged 9.2%. The fall in the ratio fits with a world of buoyant consumer confidence and low returns on savings. But it also suggests that consumers have been saving less to sustain spending.
To assess just how stretched the consumer sector is we need a broader picture, one which includes mortgages and the asset side of consumers' balance sheets.
The bulk of consumer debt, some 85%, is accounted for by mortgages. Tougher regulation and greater caution on the part of lenders mean that growth in mortgage borrowing has been pretty subdued. Over the last 12 months mortgage borrowing rose by 2.8% compared to a 10.3% increase in overall personal borrowing and a 15.0% rise in car finance deals.
With mortgages accounting for the lion's share of borrowing and growing only slowly, overall levels of consumer borrowing relative to GDP have declined in recent years. The ratio of UK household debt to GDP peaked at 173% in 2007 before falling to 150% in 2015, the latest year for which data are available.
Consumer debt levels are lower in many other countries, including the US, France and Germany, but at 150% the UK debt to GDP ratio does not look extreme by international standards. Denmark, the Netherlands, Norway, Austria and Switzerland, are running ratios well in excess of 200% of GDP.
An alternative measure of sustainability, comparing debt to household assets, also looks reassuring.
Rising equity and house prices have pushed up the value of household assets faster than the growth in consumer borrowing. As a result, the ratio of consumer debt to assets has dropped from 20% to 15%. So in aggregate, the value of UK consumers' asset are almost seven times higher than their debts. But this broader, benign view requires interest rates to stay low – at least until we see sustained growth in consumer spending power. Higher interest rates would mean higher debt serving costs and could trigger a fall in asset values. In the past sharply higher interest rates and falling house and equity prices have been the catalyst for consumer recessions.
Today the value of consumers' earnings are falling as inflation surges. But the scope for consumers to finance spending by borrowing more or cutting back on saving is limited. Banks are already tightening criteria for granting consumer credit. And levels of savings from income are at historically low levels.
There is one further important issue: the question of the distribution of debts and assets across consumers.
The last 20 years have seen a sharp rise in levels of student debt. In 2016-17 student debt stood at almost £90 billion, equivalent to roughly 7% of total existing household debt. Because student debt is backed by the government and repayments are contingent on income, it is not included in the official measure of household debt. Yet in coming years student debt will become an increasingly drain on consumers' incomes as new generations leave higher education.
Meanwhile rising house prices have raised the value of older consumers' assets but made it harder for younger consumers to get on the housing ladder. The Resolution Foundation think-tank reports that the likelihood of a millennial owning their own home at the age of 30 is half that of a baby boomer household at the same age.
The result is an increasing polarisation of debt and assets between younger and older consumers.
To me there are two obvious messages to be drawn from all this. Consumer spending is set to slow markedly over the next couple of years. And the distribution of assets and debt between the generations will remain a hot political subject.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
