The key chart
The key message
The context for the (now) eagerly anticipated OBR forecasts for the UK economy and its fiscal outlook remains very challenging. To re-use an old gag, if I was the OBR, I would not start from here!
The UK has already returned to the unsustainable world of pre-COVID economics with twin domestic sector deficits counterbalanced by significant current account deficits (ie, RoW surpluses).
Falling real disposable incomes in the face of the largest growth in household (HH) inflation since 4Q81 cloud the outlook for household consumption. In response, the HH savings ratio has fallen sharply from its 2Q20 peak already, but remains above its pre-pandemic level and previous OBR forecasts. A pressure release valve, of sorts, remains here.
Despite a period of sustained HH sector deleveraging since the GFC, the level of indebtedness remains high in absolute terms, and the prospect of high borrowing costs through to 2023 raise the risks of heightened debt vulnerability, however. A far more limited pressure release valve (ie, more HH borrowing) here.
Previous OBR forecasts have assumed dramatic role reversals in the position of the UK government vis-à-vis the HH sector combined with sustained and significant current account deficits. This unattractive and unsustainable scenario reflects the persistent flaw in conventional macro thinking that typically ignores the risks associated with private debt while seeing public debt as a problem rather than a solution.
The risk remains that “more-of-the same” forecasts will be interpreted as reverse engineering rather than reassurance for domestic and international investors and financial markets.
If I was the OBR
The UK has already returned to the unsustainable world of pre-COVID economics with twin domestic sector deficits (see chart above) counterbalanced by significant current account deficits. According to the latest ONS statistics for the 2Q22 (published 30 September 2022), the domestic private sector increased its net borrowing position to -0.7% GDP from -0.6% GDP in 1Q22 and a net lending position of 3.1% GDP in 4Q21. In other words, private sector investment in the first two quarters of 2022 has exceeded its income (minus consumption and taxes).
The domestic public sector reduced its net borrowing position to -4.9% GDP from -6.6% GDP in the 1Q22, reflecting a drop in health expenditure, but this was still above the 4Q21 net borrowing position of -3.7% GDP.
This left the UK economy dependent on the RoW running a net lending position of -5.6% GDP in 2Q22 (see key chart above).
Falling real disposable incomes in the face of the largest growth in HH inflation since 4Q81 cloud the outlook for household consumption. Nominal HH gross disposable income grew 1.8% QoQ in 2Q22, up from 1.4% in 1Q22 and 1.0% in 4Q21.
This was offset, however, by quarterly HH inflation of 3.1% up from 2.1% in 1Q22 and 1.3% in 4Q21 (see chart above).
Real HH disposable income fell -1.3% QoQ, from -0.7% in 1Q22 and -0.3% in 4Q21 (see chart below). On a YoY basis, real HH disposable income fell -2.5% in 2Q22, from -1.1% in 1Q22 and -0.6% in 4Q21.
In response, the HH savings ratio has fallen sharply from its 2Q20 peak but remains above pre-pandemic levels and previous OBR forecasts. During the COVID-19 pandemic the HH savings ratio increased from its 2018-19 average of 5.3% to 26.8%, reflecting the rise in forced and precautionary savings. It has now fallen to 7.6% in 2Q22 from 8.3% in the previous two quarters.
On a positive note, room remains for HH to support future consumption by running down their savings further (see chart above). For reference, the previous OBR forecasts assumed that the savings rate would fall faster that recent trends (to below 3%) and remain below 5% for the forecast period to 1Q27.
Despite a period of sustained HH sector deleveraging since the GFC, the level of indebtedness remains high in absolute terms and the prospect of high borrowing costs raise debt vulnerability risks.
The HH debt ratio (debt as a %age of GDP) has fallen from a peak of 97% GDP in 1Q10 to 85% in 1Q22 (see chart above). The BIS considers 85% GDP to be the “threshold level” above which debt becomes a constraint on future growth.
Perhaps more importantly, if the latest market forecasts and the Bank of England’s recent debt vulnerability forecast turn out to be correct, rates could reach the levels at which the share of HHs with high, adjusted debt service ratios – those who are typically likely to struggle with debt repayments – could return to pre-GFC highs in 2023.
Previous OBR forecasts have assumed dramatic role reversals in the position of the UK government vis-à-vis the HH sector combined with sustained and significant current account deficits (see chart above).
This is an unattractive and unsustainable scenario but one that reflects the persistent flaw in conventional macro thinking that typically ignores the risks associated with private debt while seeing public debt as a problem rather than a solution.
The risk remains that “more-of-the same” forecasts will be interpreted as reverse engineering rather than reassurance for domestic and international investors and financial markets.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.