Nov
12
Economic Recovery or Bust
Filed Under Inflation, Interest Rates
The global economic recovery seems to be gathering momentum but for the Bank of England there is a bigger problem, the British consumer. To be accurate, the indebted British consumer.
Today’s release of the Bank of England quarterly inflation report was a mixture of good and bad news. The good being that the British economy is expected to grow for the next two years, with GDP forecast to remain “marginally above trend” at just below 3% by the middle of next year.
The bad being that consumer spending had returned to trend and consumers were borrowing and spending more again. The short blip down in the consumer expenditure trend, which had been observed in August’s inflation report, is now looking more like a pause in the otherwise relentless pursuit of all things consumer and credit.
The combination of soaring house prices and cheap debt, which has fuelled the boom in consumer borrowing and insulated the UK from the worst of the global slowdown, is now in danger of bringing everything to a grinding halt and throwing the British economy into recession.
Just six days ago, the Bank’s Monetary Policy Committee (MPC) raised interest rates by 0.25% points from a 48-year low to 3.75% amid growing concerns over the inability of consumers to moderate their use of credit. A sign that the multi-decade secular bear market in the Base Rate is over.
Growth in secured debt is up 14% over the last year and the level of unsecured borrowing continues to hit new highs. The household debt to income ratio is 130%.
“There is a risk that heavily-indebted households will be badly affected by changes in economic circumstances or interest rates”, said Mervyn King, Governor of the Bank of England at today’s press conference.
Mr . King warned, “Everyone needs to think carefully about the amount of debt they can afford”. A clear indication that everyone with debt should review their situation and decide if they can still afford it as interest rates continue to rise. If not, they should adjust their finances accordingly.
The report noted that households “care about the resources available for immediate consumption, which will be affected by their debt-servicing costs”. Highlighting that indebted households are less concerned with actually paying off the debt than they are with the size of the monthly repayments and how much that leaves them to spend on other things.
Mortgage debt as a percentage of household income has risen from 76% in the first quarter of 1997 to 96% in the second quarter of 2003, during which time house prices have risen by 100% on average.
Figures recently released by both the Nationwide Building Society and the Halifax report house prices are still rising at unsustainable levels, with expectations that house prices will have risen by 15% in 2003.
“The longer house price inflation continues to exceed growth in average household income … the greater the risk of a sharp adjustment in house prices and thus spending further ahead”, the Bank said.
It is not the desire of the Bank that the British consumer stops borrowing altogether, that would be just as bad for the British economy as the continued debtathon. But moderation is needed to ensure that house price inflation can fall to a more realistic and sustainable level, such as single digits. That in turn would help reduce the appetite for credit, which would ultimately negate the need for some of the talked about interest rate rises.
But should the consumer not reign back his use of credit, then prospective interest rate hikes will need to be more severe. The predictable response would be, once an unbearable level is reached, a noticeable decline in spending by nervous consumers and an eventual decline in house prices.
The global recovery is showing overall signs of strengthening. The British economy, because it is not part of Euroland, is in a better shape than continental Europe to benefit from it. The only thing that stands in the country’s way is the record levels of debt. The question is, “Which do you want, economic recovery or bust?”
