July 2022 – Chris Mallin Macro Perspectives

“Accounting for inflation – part 2”

Inflation also distorts the 2Q22 message from the UK money sector

The key chart

**Nominal and real growth rates in UK M4Lex** (Source: BoE; CMMP)

The key message

In my previous post, I explained how rising inflation distorts the 2Q22 messages from the euro area’s (EAs) money sector significantly. The same is true for the UK too.

Ignore inflation and the messages from the UK’s money sector are broadly positive for the economic outlook. The three key signals from the UK money sector that I have been following consistently since early 2021 are all sending broadly positive messages – UK HHs have stopped hoarding money, they are borrowing more to fund consumption, and money and credit cycles are re-synching. Growth rates in COCO-based consumer credit and NFC lending are also rising in the UK while the growth in FIRE-based mortgage lending is slowing. Does this sound familiar?

Rising inflation is over-taking these positive trends, however. Lending to private sector companies and households (M4Lex) is falling sharply in real terms (-6.5% YoY). Trends in real HH credit and real NFC credit are slowing sharply and in a coordinated fashion. This matters because these factors typically display coincident and lagging relationships with real GDP.

As in the EA, plenty of information for optimists and pessimists to debate here but with increasing ammunition for the pessimists…

Accounting for inflation – part 2

In the previous post, I explained how rising inflation distorts the 2Q22 messages from the euro area’s (EAs) money sector significantly. The same is true for the UK too.

The good news

Ignore inflation and the messages from the UK’s money sector are broadly positive for the economic outlook.

**Trends in monthly HH money flows** (Source: BoE; CMMP)

Monthly HH money flows have moderated slowly, reflecting lower levels of uncertainty. The monthly flow fell from £5.2bn in May 2022 to £1.5bn in June 2022. This is well below the average pre-pandemic flows of £4.6bn and the peak flow of £26bn recorded in May 2020 when HH uncertainty levels peaked at the height of the pandemic crisis (see chart above).

**Quarterly trends in HH money flows** (Source: ECB; CMMP)

The quarterly HH money flow in 2Q22 was £12.2bn (see chart above). This compares with the average pre-pandemic flows of £11.7bn. The message here is the same – HHs in the UK are no longer hoarding cash in the form of bank deposits. This is reflected, in turn, in the slowdown in broad money growth (see below).

**Trends in monthly consumer credit flows** (Source: ECB; CMMP)

The demand for credit has recovered. Monthly consumer credit flows rose to £1.8bn in June 2022 from £0.9bn in May 2022, well above the pre-pandemic average flows of £1bn. The YoY growth rate of 6.5% was the highest rate of growth since May 2019. Within this, the annual growth rate of credit card borrowing was 12.5% while other forms of consumer credit grew 4.1%. These were the highest rates of growth since November 2005 and March 2020 respectively.

**Quarterly trends in consumer credit** (Source: BoE; CMMP)

The quarterly flow of consumer credit rose from £3.1bn in 4Q21 and £3.6bn in 1Q21 to £4.2bn in 2Q22 (see chart above). The 2Q22 flow was the largest quarterly flow since 2Q18 and was above the pre-pandemic average of £3.6bn. There have now been five consecutive quarters of positive consumer credit flows, with current flows in-line or slightly above pre-pandemic levels.

**Growth trends in broad money (M4ex) and lending (M4Lex)** (Source: BoE; CMMP)

After the recent and unprecedented de-synchronisation of money and credit cycles, growth rates in UK money supply and private sector credit are converging (see chart above). The YoY growth rate in money (M4ex) slowed from 5.4% in May 2022 to 4.4% in June 2022. At the same time, the YoY growth rate in lending (M4Lex) fell from 3.9% to 2.3%. While the gap between the two growth rates widened slightly from 1.5ppt to 2.1ppt, it has narrowed considerably from its peak of 11.5ppt in February 2021.

**Growth trends in mortgages, consumer credit and NFC lending** (Source: BoE; CMMP)

Growth rates in COCO-based consumer credit and NFC lending are rising in the UK while the growth in FIRE-based mortgage lending is slowing (see chart above).

As described above, consumer credit is growing at the fastest rate since May 2019. NFC lending has also recovered to 2.0% YoY, marking five consecutive months of positive YoY growth.

Of course, mortgages remain the largest segment of UK private sector credit (89% of total HH credit and 61% of total PSC). The relative stability of mortgage demand has been a key feature of the messages from the UM money sector for some time. However, net borrowing of mortgage debt decreased from £8.0bn in May 2022 to £5.3bn in June 2022. The YoY growth rate also declined from 4.6% in May 2022 to 3.8% in June 2022, the slowest rate of growth since February 2021. Approvals for house purchases, an indicator of future borrowing, decreased to 63.700 in June 2022 from 65,700 in May. This is below the pre-pandemic average of 66,700.

The bad news

Take inflation into account and the messages are very different, however. Lending to private sector companies and HHs (M4Lex) slowed from 3.9% YoY in May 2022 to 2.3% YoY in June 2022 (see chart above). In real terms, M4Lex fell -6.5% YoY in June 2020, with all forms of lending declining in real terms.

**Growth trends (real terms) in HH and NFC credit** (Source: BoE; CMMP)

Furthermore, trends in real HH credit and real NFC credit are slowing sharply in a coordinated manner. This matters because these factors typically display coincident and lagging relationships with real GDP over time (see “Look beyond the yield curve” for more details).

Conclusion

The three key signals from the UK money sector that we have been following consistently since early 2021 are all sending broadly positive messages – UK HHs have stopped hoarding money, they are borrowing more to fund consumption, and money and credit cycles are re-synching. Growth rates in COCO-based consumer credit and NFC lending are also rising in the UK while the growth in FIRE-based mortgage lending is slowing.

Rising inflation is over-taking these positive trends, however. Lending to private sector companies and households (M4Lex) is falling sharply in real terms (-6.5% YoY) and traditional coincident and lagging monetary indicators have turned down sharply and in a coordinated fashion. Plenty of ammunition here for pessimists.

The format and presentation of this post mirrors that of the previous post deliberately. Why? Because the messages from the UK and EA money sectors have been very similar during the pandemic. The next post will compare and contrast these trends more closely.

Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.

“Accounting for inflation”

Inflation distorts the 2Q22 messages from the money sector

The key chart

**Nominal and real growth rates in EA private sector credit** (Source: ECB; CMMP)

The key message

Rising inflation distorts the 2Q22 messages from the euro area’s (EAs) money sector significantly.

Ignore inflation and the three key signals that I have been following consistently since early 2021 are all sending broadly positive messages for the region’s economic outlook. Monthly household (HH) deposit flows have moderated sharply, reflecting lower levels of uncertainty. The demand for consumer credit has recovered with the largest quarterly flows since the recovery began in 2Q21. Growth rates in money supply and private sector credit have also re-aligned as money and credit cycles have re-synched with each other. Finally, the contribution of productive COCO-based lending has increased, with growth in lending to corporates (NFCs) outstripping mortgage growth in June 2022. So far, so good.

Take inflation into account and the messages are very different, however. Private sector credit (PSC) is slowing in real terms (-2.3% YoY). With the exception of lending to non-monetary financial corporations (8% of total PSC), the growth rates in all forms of PSC are declining in real terms. Furthermore, trends in real M1, real HH credit and real NFC credit are all slowing sharply in a coordinated manner. This matters because these factors typically display leading, coincident and lagging relationships with real GDP.

Plenty of information for optimists and pessimists to debate but with increasing ammunition for the pessimists…

Accounting for inflation

Rising inflation distorts the 2Q22 messages from the euro area’s (EAS) money sector significantly.

The good news

Ignore inflation and the messages are broadly positive for the region’s economic outlook.

**Trends in monthly HH deposit flows** (Source: ECB; CMMP)

Monthly HH deposit flows have moderated sharply, reflecting lower levels of uncertainty. The monthly flow fell to €9bn in June 2022 (see chart above). This is well below the average pre-pandemic flows of €33bn and the peak flow of €78bn in April 2020 when HH uncertainty levels peaked at the height of the pandemic crisis.

**Quarterly trends in HH deposit flows** (Source: ECB; CMMP)

The quarterly HH deposit flow in the 2Q22 was €53bn (see chart above). This compares with average quarterly pre-pandemic flows of €90bn. The message here is the same – HHs in the EA are no longer hoarding cash in the form of bank deposits. This is reflected, in turn, in the slowdown in broad money growth (see below).

The demand for consumer credit has recovered. Monthly consumer credit flows slowed from €2.4bn in April 2022 and €3.3bn in May 2022 to €1.8bn in June 2022 (see chart above). The YoY growth rate of 3.3% was the second highest rate of growth since consumer credit recovered in April 2021, however (after May 2022’s 3.4% YoY).

**Quarterly trends in consumer credit** (Source: ECB; CMMP)

The quarterly flow of consumer credit in 2Q22 of €7bn was the largest quarterly flow since the recovery started in 2Q21. There have now been five consecutive quarters of positive consumer credit flows (see chart above), albeit these flows remain below the pre-pandemic levels.

**Growth trends in broad money (M3) and private sector credit** (Source: ECB; CMMP)

After the recent unprecedented de-synchronisation of money and credit cycles, growth rates in EA money supply and private sector credit have now converged (see chart above).

The YoY growth rate in broad money (M3) fell to 5.7% in June 2022, the slowest rate of growth since February 2020. In contrast, the growth rate in private sector credit rose to 6.1% YoY, the fastest rate of growth since private sector credit growth turned positive in Mach 2015.

Recall that in January 2021, the gap between the growth rate in M3 and the growth rate in private sector credit was 8ppt. In June 2022, private sector credit grew faster than broad money, suggesting that the period of excess liquidity (see green shaded area in graph above) may be ending.

**Trends in PSC and contribution from COCO-based lending** (Source: ECB, CMMP)

The contribution of productive COCO-based lending is also increasing with the growth in lending to corporates (NFCs) outstripping the growth in mortgages. COCO-based lending contributed 2.5ppt to the total (unadjusted) growth rate in private sector credit of 5.8% (see chart above). This compares with a contribution of only 0.6ppt a year earlier.

Less productive FIRE-based lending is still contributing more (3.3ppt) than COCO-based lending to total loan growth, but corporate lending is now growing faster (5.9% YoY) than mortgage lending (5.3% YoY). Corporate and mortgage lending represent the largest segments of COCO-based and FIRE-based lending respectively.

**Growth trends (% YoY, nominal) in mortgages and NFC lending** (Source: ECB; CMMP)

The bad news

Take inflation into account and the messages are very different, however. PSC is growing 6.1% YoY in nominal terms, the fastest rate of growth since January 2009. In real terms, however, PSC is falling -2.3% YoY. With the exception of lending to non-monetary financial corporations (8% of total PSC), the growth rates in all forms of PSC are declining in real terms.

**Growth trends (% YoY, real terms) in M1, HH credit and NFC credit** (Source: ECB; CMMP)

Furthermore, trends in real M1, real HH credit and real NFC credit are all slowing sharply in a coordinated manner. This matters because these factors typically display leading, coincident and lagging relationships with real GDP over time. (See “Look beyond the yield curve” for more details about these indicators)

Conclusion

The three key signals from the money sector that we have been following consistently since early 2021 are all sending broadly positive messages – HHs have stopped hoarding money, they are borrowing more to fund consumption, and money and credit cycles are re-synching. The on-going recovery in productive COCO-based lending is also positive.

Rising inflation is over-taking these positive trends, however. PSC is falling in real terms and traditional leading, coincident and lagging monetary indicators have turned down sharply and in a coordinated fashion. Plenty of ammunition here for pessimists…

Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.

“Financial inequality and debt vulnerability”

The BoE introduces an improved measure of affordability

The key chart

**Share of outstanding mortgages and consumer credit by income decile** (Source: BoE; CMMP)

The key message

Rising financial inequality means that lower-income HHs have less flexibility to adjust their spending in response to rising prices and are less likely to have a cushion of savings to protect them. But what does this mean for debt vulnerability in the UK, given that lower-income HHs also hold a relatively small share of outstanding mortgages and consumer credit?

In its latest “Financial Stability Review” (5 July 2022), the Bank of England introduced a new measure of HH debt affordability that takes account of these factors to deliver an improved assessment of HH vulnerability to rising prices and higher interest rates. The key points are:

The share of HHs with high, adjusted debt service ratios (DSRs) i.e. those who are typically more likely to struggle with repayments, is currently in-line with historic averages and well below pre-GFC peaks
The BoE believes that this share is unlikely to rise substantially in 2022. Further fiscal measures will cushion serviceability this year and the shift towards fixed mortgages (80% outstanding stock) delays the pass through effect of higher rates
Looking forward, the BoE expects this share to increase above its historic average in 2023, but to remain “significantly below the peaks seen ahead of the GFC.”

[In response to questions, Sir Jon Cunliffe, the Deputy Governor for Financial Stability, indicated that rates would have to rise significantly (200-500bp) above current market expectations for the bank rate (3.0%) for the share to reach previous highs.]

The obvious risks to this positive assessment, acknowledged by the BOE, include weaker growth, higher unemployment, persistent inflation, higher rates etc.

In the context of the recent deterioration in the net lending position of the HH sector, the risk that HHs may increasing their borrowing in order to fund rising living costs also remains important.

Financial inequality and debt vulnerability

What is the impact of financial inequality on household (HH) debt vulnerability?

Financial inequality means that lower-income HHs have less flexibility to adjust their spending in response to rising prices and are less likely to have a cushion of savings to protect them.

**Share of income spent on taxes and essentials by gross income decile** (Source: BoE; CMMP)

The share of income spent on essentials and taxes varies considerably across the UK income distribution (see chart above). HHs in the lowest income decile, for example, spend 94% of their gross income on taxes and essentials. In contrast, HHs in the highest income decile spend only 47% of their gross income on taxes and essentials. This means that lower-income HHs have much less freedom to change their behaviour in response to rising inflation.

**HH savings ratio (%) broken down by gross income decile** (Source: BoE; CMMP)

The savings ratio of lower-income HHs is also much lower than the savings ratio of higher-income HHs (see chart above). HHs in the bottom three income deciles save less than 6% of their gross income. This contrasts with HHs in the top two income deciles who save more than 30% of their gross income.

Obviously, this means that lower-income HHs are much less likely to have a savings cushion than can protect against rising prices. ( Note also that the COVID-19 pandemic led to a further widening of the savings disparity in the UK, as noted in previous posts.)

That said, lower income HHs are also likely to hold a smaller share of both outstanding mortgages and consumer credit (see chart above).

**Share of outstanding mortgages by income decile** (Source: BoE; CMMP)

The bottom three income deciles account for 1.6%, 1.2% and 2.3% of total outstanding mortgages respectively, a cumulative market share of just over 5% (see chart above). The top income decile accounts for 33% of total mortgages alone and the top three income deciles together account for more than two-thirds of total mortgages.

The breakdown of consumer credit follows a similar, if less extreme, pattern. The bottom three income deciles account for 1.5%, 3.0% and 4.0% respectively, a cumulative market share of just over 8% (see chart below). The top income decile accounts for 20% of total consumer credit alone and the top three income deciles accounts for more than half of total consumer credit.

**Share of outstanding consumer credit by income decile** (Source: BoE; CMMP)

In its latest “Financial Stability Review”, the Bank of England introduces a new measure of HH debt affordability that takes account of these factors to deliver an improved assessment of the HH vulnerability to rising prices and higher interest rates.

The BoE claims that, “the share of HHs with high cost of living adjusted DSRs on either their mortgage or consumer credit has remained significantly below the pre-GFC peaks over the past few years.”

**Share of HHs with high adjusted DSR on mortgage debt** (Source: BoE; CMMP)

In the case of mortgages, the BoE estimates that 1.7% of HHs had a high, adjusted DSR at the end of 1Q22, up from 1.4% in 1Q20. This is close to the historic average but below the pre-GFC peak of 2.8% (see chart above). The BoE is expecting this share to remain at around the current level for the rest of 2022. This assumes that government support measures will relieve the pressure of rising living costs and also reflects the fact that 80% of outstanding mortgages are fixed rate now versus 55% five years ago.

**Share of HHs with high adjusted DSR on consumer credit** (Source: BoE; CMMP)

The story for consumer credit is much the same. The share of high, adjusted DSRs for consumer credit was 6.4% in 1Q22, up from 5.5% in 1Q20. This is also well below the pre-GFC peak of 9.5%. Again, the BOE is not expecting a major change here during the rest of 2022.

Looking slightly further ahead, the BoE believes that the shares of HHs with a high, adjusted DSR for both mortgages and consumer credit will increase in 2023, but “would remain significantly below the peaks seen ahead of the GFC.”

In response to questions, Sir Jon Cunliffe, the Deputy Governor for Financial Stability, indicated that rates would have to rise significantly (200-500bp) above current market expectations for the bank rate (3.0%) for the share to reach previous highs.

The obvious risks to this positive assessment, acknowledged by the BOE, include weaker growth, higher unemployment, persistent inflation, higher rates etc. In the context of the recent deterioration in the net lending position of the HH sector, the risk that HHs may increasing their borrowing in order to fund rising living costs also remains important.

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.

“Don’t be surprised – part 2”

Short-term comfort but more serious medium-term concerns

The key chart

**UK net lending (+) / net borrowing (-) by sector from the capital account as % age of GDP**
(Source: ONS; CMMP)

The key message

Two official UK data points released last week – the 1Q22 household (HHs) savings ratio and May 2022’s consumer credit growth – provide short-term comfort but may hide more serious medium-term concerns for the UK economic outlook.

The positive news: HHs have room to adjust to falling real incomes by running down savings and increasing borrowings further. The adjustment process here remains at an early stage (see “Don’t be surprised”).

The negative news: while the net lending position of the HH sector widened slightly in 1Q21 (0.9% GDP), the UK private sector, in aggregate, moved into a net borrowing position (-1.4% GDP). At the same time, the public sector increased its net borrowing position further (-6.7% GDP).

So what? The irony of post-Brexit Britain, is that the economy is currently more dependent than ever on the net lending of the RoW. The challenges of the pre-Covid period have returned already – twin domestic deficits counterbalanced by significant (and persistent?) current account deficits.

These trends are not unexpected but that does not mean that they are either welcome or sustainable.

Don’t be surprised – part 2

Two official UK data points released last week – the 1Q22 HHs savings ratio and May 2022’s consumer credit growth – provide short-term comfort but medium-term concerns for the UK economic outlook.

**Real HH disposable income growth (% QoQ)** (Source: ONS; CMMP)

The context here is that real HH disposable income has fallen for four consecutive quarters (see chart above). Official forecasts suggest that this will continue for the rest of 2022 and in 2023.

In response, the same forecasts assume that HHs will reduce their savings ratio to a new low in 1Q23 by running down the excess savings built up during the pandemic (see chart below) and/or by increasing their borrowing. The positive news is that this process has hardly begun.

**Trends in HH savings ratio** (Source: ONS; OBR; CMMP)

The 1Q22 HH savings ratio was 6.8%, unchanged from the 4Q21 and above the OBR’s forecast of 6.3% (see chart above). Of course, this represents a large decline from the 2Q20 peak of 23.9%, but the 1Q22 ratio is only slightly below the 20-year average of 7.1%. (Note that the OBR expects the savings ratio to fall further to 2.8% in 1Q23.)

**Monthly HH money flows as a multiple of pre-pandemic flows** (Source: BoE; CMMP)

Furthermore, while monthly HH money flows have moderated sharply, they remain slightly above pre-pandemic levels during 2Q22 (see chart above). The result? Rather than declining, the stock of excess savings is increasingly slightly still (see chart below). CMMP analysis estimated that excess savings currently total £167bn.

**CMMP estimates for build up of excess savings** (Source: BoE; CMMP)

As an aside, the ONS also released the results of its modelling of the breakdown of the excess savings last week. The modelling suggests that so-called “forced savings” accounted for 75% of the increase in HH savings during the pandemic.

**Estimates for excess savings broken down by type** (Source: BoE; ONS; CMMP)

According to their calculation, this amounts to over £140bn, or around 10% of annual disposable income. This matters because forced savings are typically released relatively quickly to support economic activity (see “Forced versus precautionary”).

**Monthly flows (£bn) and YoY growth rates in consumer credit** (Source: BoE; CMMP)

Consumer credit grew 5.7% YoY in May 2022, unchanged versus the previous month (see chart above). This is the fastest rate of growth since February 2020 (5.8%) due in part to base effects. The monthly flow of consumer credit in May 2022 fell, however, from £2.0bn in February, £1.3bn in March, and £1.4bn in April 2022 to £0.8bn. May’s monthly flow is also below the pre-pandemic average of £1.1bn.

**HH debt to income ratio (%)** (Source: ONS; CMMP)

In other words, the demand for consumer credit has recovered – a welcome trend – but is not increasing at a rate that would suggest significant levels of distressed borrowing. HH debt as a percentage of disposable income, while elevated in absolute terms, has remained relatively stable since 2015 and below the peaks seen in the built up to the GFC.

So far, so good. Recent trends reflect a return to normality and suggest that HHs still have room to adjust to falling real incomes. It is not all good news, however. In “Don’t be surprised”, I highlighted the negative implications of forecast trends for both financial equality and economic sustainability. Last week’s data also shines further light on question of economic sustainability.

**HH net lending/borrowing (% GDP)** (Source: ONS; CMMP)

The net lending of the UK HH sector, i.e. the surplus resources that the HH sector makes available to other sectors, rose from 0.6% GDP in 4Q21 to 0.9% GDP in 1Q22 (see chart above). However, the UK private sector in aggregate shifted from a net lending position of 4.3% GDP in 4Q21 to a net borrowing position of 1.4% of GDP.

When combined with the net borrowing of the UK public sector of 6.7% in 1Q22, the UK’s net borrowing position with the rest of the world increased to 8.4% GDP (see chart below).

The irony of post-Brexit Britain, is that the 1Q22 net borrowing position with the rest of the world exceeds the previous highest borrowing seen in 4Q201 (7.0% GDP).

With both domestic sectors currently running net borrowing positions, the UK is more dependent than ever on net lending from the RoW (see chart above).

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.