UK – Page 7 – Chris Mallin Macro Perspectives

“Global debt dynamics – I”

Why does the changing nature of global debt matter?

The key chart

**Changes in breakdown of global debt (% total) since the GFC** (Source: BIS; CMMP)

The key message

“Private debt causes crises – public debt (to some extent) ends them.”
Professor Steve Keen, June 2021

While a great deal of attention is focused on the fact that global debt levels hit new highs during 2021, too little attention is given to the important changes that have taken place in the structure of global debt since the GFC.

This matters because conventional macro theory struggles to deal with the implications here, since it typically ignores private debt while seeing government debt as a problem rather than as a solution.

There has been an important shift away from household (HH) debt towards government debt at the aggregate, global level since the Global Financial Crisis (GFC). Debt dynamics in advanced economies have driven this shift, most notably in the US and the UK. In contrast, the structure of emerging economies’ (EMs) debt remains broadly unchanged, with a structural bias towards private sector debt. These trends matter for a number of reasons:

First, and in contrast conventional theory, we know that government deficits increase the supply of money (not the demand for money), crowd-in investment private spending (as opposed to crowding it out) and depress interest rates (rather than driving them up).
Second, and from this, we also know that while private sector debt typically causes crises, public sector debt typically limits their damage/ends them.
Third, the structure of US and UK debt is now the mirror image of the pre-GFC period, which reduces associated risks since governments face different financial constraints to HHs and NFCs and cannot, as currency issuers, become insolvent. Risks associated with excess credit growth exist more obviously in other advanced economies.
Fourth, EMs face very different risks to advanced economies. These are associated largely with the level of NFC debt, the growth rate in HH debt and the increasing dominance of China in EM debt.

Global debt dynamics – I

Debt dynamics since the GFC

In the “Seven lessons from the money sector in 2021”, I noted that our understanding of global debt dynamics is improved significantly by extending analysis beyond the level of debt to include its structure, growth and affordability.

In this first post of 2022, and the first in a series of five posts reviewing current global debt dynamics, I focus on the implications of the changes that have taken place in the structure of global debt since the Global Financial Crisis (GFC).

**Global debt levels ($tr) and debt ratios (% GDP) as at end 2Q21** (Source: BIS; CMMP)

A great deal of attention has focused on the fact that global debt levels hit new, record highs in 2021 (see chart above). According to BIS statistics released on 6 December 2021, total debt (to the non-financial sector) reached $225tr at the end of 2Q21. NFC debt reached $86tr (38% total), government debt reached $83tr (37% total) and HH debt reached $55tr (25% total).

Note that while it is common to aggregate these three categories of debt together, it is also important to recognise that NFC and HH debt sit on the liabilities side of private sector balance sheets, while government debt sits on the assets side of private sector (and RoW) balance sheets.

Note also, that while debt levels are at record highs, debt ratios (ie, debt as a percentage of GDP) are below their 4Q20 peaks in each category.

Too little attention has focused, however, on the important changes that have taken place to the structure of global debt since the GFC (see chart above). While NFC debt’s share of total debt has remained relatively stable at just under 40%, there has been an important shift away from HH debt to government debt over the period. HH debt’s share of total debt has fallen from 32% to 25% (see chart below). In contrast, government debt’s share of total debt has risen from 29% to 37%.

**Trends in shares of HH and government debt (% total debt) since GFC** (Source: BIS; CMMP)

Debt dynamics in advanced economies have driven this shift, most notably in the US and the UK (see chart below). In advanced economies, the US and the UK the share of HH debt has fallen from 34% to 26%, from 42% to 28% and from 43% to 30% respectively. In contrast, the respective shares of government debt to total debt have risen from 29% to 42%, from 26% to 44% and from 20% to 45% respectively. Similar shifts have also taken place in the EA, albeit in a much more muted fashion. This reflects a much lower (27%) share of HH debt at the time of the GFC in the EA.

**Changes in structure of global debt by region** (Source: BIS; CMMP)

The structure of EM debt remains broadly unchanged, however, with a bias towards private sector debt. At the end of 2Q21, the shares of HH, NFC and government debt to total debt in EM were 22%, 50% and 28% respectively.

**Trends in structure (% total) of EM debt since GFC** (Source: BIS; CMMP)

Note that China’s share of total EM debt has risen from 31% to 64% over the period. In other words, the EM debt story is increasingly a “China debt” story. For reference, China’s share of total global debt has also increased from 5% to 21% over the same period (see chart below). In contrast, EM excluding China’s share of total global debt has remain unchanged.

**Trends in EM share of global debt since GFC** (Source: BIS; CMMP)

Why does this matter?

This matters for a number of reasons. First, and in contrast conventional theory, we know that government deficits increase the supply of money (not the demand for money), crowd-in investment private spending (as opposed to crowding it out) and depress interest rates (rather than driving them up).

Professor Steve Keen has written extensively on this subject. He notes that, “rather than deficits meaning that the government has to take money away from the private sector – which is what the mainstream thinks the government does when it sells bonds to cover the deficit – the deficit creates money by increasing the bank deposits of the private sector”. In simple terms, by not studying the accounting involved in government deficits, Keen argues that they (mainstream economists) have wrongly classified them as increasing the demand for money, when in fact they increase the supply of money. I agree.

The implication here is that many arguments regarding global debt are in fact, back-to-front. Government deficits crowd in private spending and investment by increasing the supply of money. They also typically drive down interest rates rather than driving them up.

Second, and from this, we also know that while private sector debt typically causes crises, public sector debt typically limits their damage/ends them. Consider the EA’s fiscal rules that put limits on government debt and deficits but completely ignored private debt and credit and the history of Spanish debt dynamics after the introduction of the euro (see chart below).

**Ignore excess private sector debt growth at your peril I – Spain** (Source: BIS; CMMP)

After the introduction of the euro, government debt in Spain fell from 70% to 36% in March 2008. In contrast, private sector debt rose from 80% of GDP to 208% of GDP over the same period before peaking at 227% in 2Q10 at the height of the Spanish banking crisis (see chart above). Similar trends were also seen in other advanced economies. The chart below illustrates trends in private sector credit and government debt in the US.

Ignore excess private sector growth at your peril II – the US (Source: BIS; CMMP)

Excess growth in private sector debt up to a crisis point is followed by increases in government debt post-crisis in response to the collapse in demand as credit growth turns negative and the private sector reduces leverage. In short, recent history supports Professor Keen’s hypothesis that private debt causes crisis, while public debt ends them (or limits their damage). This topic and these case studies are developed in more detail in other posts/CMMP research.

**Shift from US and UK HH debt to government debt (% total debt) since GFC** (Source: BIS; CMMP)

Third, the structure of US and UK debt is now the mirror image of the pre-GFC period (see chart above). This reduces associated risks since governments face different financial constraints to HHs and NFCs and cannot, as currency issuers, become insolvent.

**Rates of excess credit growth in EM** (Source: CMMP)

Fourth, EMs face very different risks to advanced economies. These are associated largely with the level of NFC debt, the growth rate in HH debt (see chart above) and the increasing dominance of China in EM debt – subjects that I will address in the final post in this series.

Conclusion

Global debt dynamics are a core element of CMMP analysis. While it is natural to focus initially on the new highs in global debt levels, it is also important not to miss the important messages associated with changes in the structure, growth and affordability of global debt.

The shift in the structure of global debt from HH debt to government debt has important implications for the severity of recessions, monetary dynamics, inflation, rates and investment risks. The nature of these implications also vary depending on whether governments are currency issuers (eg, US and UK) or currency users (eg, EA governments). The risks of a return to pre-pandemic policy mixes remain in all areas, however.

In the next post, I will examine dynamics in global private sector debt.

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

“Seven key lessons from the money sector in 2021”

What have the “messages from the money sector” taught us?

**Visual summary of the CMMP framework linking all economic sectors together** (Source: CMMP)

The key message

Over the past twelve months, the “messages from the money sectors” have taught us more about:

The true value in analysing global banks
How to improve our understanding of global debt dynamics
What does (and does not) constitute a pragmatic and responsible fiscal outcome
Why official forecasts for UK government spending remain flawed
How QE fuelled the “wrong type of lending” and what the ECB thinks should be done about it
How to avoid misinterpreting trends in monetary aggregates
How the behaviour of UK and euro area households reached an important inflexion point at the start of 4Q21

Unfortunately, there is a risk that the renewed rise in COVID-19 cases and emergence of the omicron variant may have masked the final lesson over the Christmas period.

Nonetheless, a final positive message from 2021 is that firmer economic foundations (and higher levels of vaccinations) suggest that both the UK and euro area regions are in a stronger position to face renewed COVID-related challenges now than they were at the start of the year.

Seven key lessons from 2021

Lesson #1: where is the true value in analysing banks?

The true value in analysing global banks comes from understanding the implications of the relationship between the money sector and the wider economy for macro policy, corporate strategy, investment decisions and asset allocations.

Based on this core foundation, CMMP analysis incorporates:

A quantifiable and objective framework linking all domestic economic sectors with each other and the rest of the world (see key chart above)
A deep understanding of global debt dynamics (see lesson #2 below)
Unique insights into the impact of global money, credit and business cycles on corporate strategy and asset allocation

Lesson #2: how can we improve our understanding of global debt dynamics?

**Household and government debt as a share (% total) of global debt** (Source: BIS; CMMP)

Our understanding of global debt dynamics is improved significantly, at the macro level, by extending analysis beyond the level of debt to include its structure, growth and affordability and, at the micro level, by distinguishing between productive (COCO-based) and non-productive sources of debt (FIRE-based), at the micro level (see lesson #5 below).

A great deal of attention focused on the fact that global debt levels hit new highs during 2021. Much less attention focused on the key structural changes that have taken place in the structure of global debt since the GFC:

There has been an important shift away from household (HH) debt towards government debt at the aggregate, global level (see chart above)
Advanced economy dynamics have driven this structural shift, especially in the US and UK
In contrast, the structure of EM debt remains broadly unchanged, with a bias towards private sector debt

I will explore the implications of these (and other structural changes) in my first post in 2022.

Lesson #3: what constitutes a pragmatic and responsible fiscal outcome?

**UK financial sector balances (4Q rolling averages, £bn)** (Source: ONS; CMMP)

“Pragmatic” and “responsible” fiscal outcomes are those that deliver a balanced economy not a balanced budget.

The three key sectors in any modern economy – the domestic private sector, the domestic government and the RoW – each generate income and savings flows over a given period. If a sector spends less than it earns it creates a surplus. Conversely, if it spends more than it earns it creates a deficit.

Extending fundamental accounting principles, we know that any deficit run by one or more economic sectors must equal surpluses run by other sector(s). This leads to the key identity pioneered by the late Wynne Godley:

Domestic private balance + domestic government balance + foreign balance (must) = zero

**UK private and public sector net savings/borrowings as %age of GDP** (Source: OBR; CMMP)

Contrary to popular political rhetoric, budget outcomes are inappropriate goals in themselves. Worse still, fiscal surpluses reduce the wealth and financial savings of the non-government sectors.

The good news during the pandemic was that the unprecedented shifts in net savings of the private sector were matched by equally unprecedented shifts in the net deficits of the public sector (see chart above for the UK experience). In other words, policy responses were both timely and appropriate. The risk looking forward is that policy makers ignore these lessons and repeat the mistakes of the post-GFC period (see also lesson #4).

Lesson #4: where are the flaws in offical UK forecasts

**Historic and forecast UK sectoral net lending – % GDP, rolling annual average** (Source: OBR; CMMP)

Forecast improvements in UK government finances from the OBR rely on dynamic adjustments by other economic sectors and unusual patterns of behaviour beyond that. The assumed end-result is one where sustained, twin domestic deficits are counterbalanced by significant and persistent current account deficits (see chart above).

The OBR described this as a “return to more normal levels.” CMMP analysis suggest it is anything but. Viewed from a sector balances perspective, the risks appear tilted to the downside ie, government finances may not recover as quickly as forecast.

Lesson #5: has QE fuelled the wrong type of lending?

**Contribution (ppt) of COCO-based and FIRE-based lending to growth (% YoY) in total lending in the euro area** (Source: ECB; CMMP)

Unorthodox monetary policy has fuelled growth in the wrong type of lending. There has been a shift away from productive COCO-based lending towards less-productive FIRE-based lending. The stock of productive lending in the euro area, for example, only returned to its previous January 2009 peak last month (November 2021).

**Outstanding stock (EUR bn) of productive COCO-based lending in the euro area** (Source: ECB; CMMP)

In other words, the aggregate growth in lending since then has come exclusively from non-productive FIRE-based lending. According to the latest ECB data, for example, FIRE-based lending accounted for 2.7ppt of the total 3.7% YoY growth in private sector lending in November 2021 (see chart below).

**What’s driving private sector lending in the euro area?** (Source: ECB; CMMP)

In its latest, “Financial Stability Review” (November 2021), the ECB calls for a policy shift away from short-term measures towards “mitigating risks from higher medium-term financial stability vulnerabilities, in particular emerging cyclical and real estate risks”.

This is a welcome development given the negative implications that the rise in FIRE-based lending has for future growth, leverage, financial stability and income inequality. Within the EA, Germany stands out given current house price and lending dynamics, the extent of RRE overvaluation and the absence of targeted macroprudential measures.

Lesson #6: how can we avoid misinterpreting monetary aggregates?

**Growth in euro area M3 (% YoY) and contribution (ppt) from M1 and private sector lending** (Source: ECB; CMMP)

Trends in monetary aggregates provide important insights into the interaction between the money sector and the wider economy but headline YoY growth figures can be easily misinterpreted, leading to false narratives regarding their implications.

The message from rapid broad money growth in the pre-GFC period, for example, was one of (over-) confidence and excess credit demand. In contrast, the message from rapid broad money growth during the COVID-19 pandemic was one of elevated uncertainty and subdued credit demand (see chart above). Very different drivers with very different implications…

CMMP analysis has focused on three key signals throughout 2021 to help to interpret recent trends more effectively: monthly household deposit flows (behaviour); trends in consumer credit demand (growth outlook) and the synchronisation of money and credit cycles (policy context).

Lesson #7: has HH behaviour in the UK and EA reached an inflexion point?

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

The behaviour of UK and euro area households reached a potentially important inflexion point at the start of 4Q21. Monthly money flows moderated sharply (see chart above) while monthly consumer credit flows hit new YTD highs ie, positive developments in two of the three key signals.

The recent rise in COVID-19 cases, the emergence of the omicron variant and renewed restrictions imposed by governments may result in these points being missed or, worse, still, reversed.

That said, and to finish on a positive note, firmer economic foundations (and higher levels of vaccinations) suggest that both the UK and euro area regions are in a stronger position to face renewed COVID challenges than they were at the start of the year.

Thank you for reading and very best wishes for a very happy and healthy new year.

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

“Missing the point?”

Household behaviour at an inflection point

The key chart

The key message

The behaviour of UK and euro area households reached a potentially important inflexion point at the start of 4Q21. Household (HH) money flows moderated sharply in October 2021 while monthly flows of consumer credit hit new YTD highs.

Recall that HHs increased their money holdings significantly during the pandemic and built up (estimated) excess savings of £162bn in the UK and €285bn in the EA – a combination of forced and precautionary savings. This meant that the rise in broad money during the pandemic was a reflection of the deflationary forces of increased savings and delayed consumption.

The accumulation of money holdings peaked during 2Q20 and again in 4Q20 and the low point in terms of YoY declines in consumer credit demand was passed in February 2021. Monthly flows of consumer credit have been positive for the past six months and hit YTD highs in October 2021 in both regions. At the same time, the accumulation of money holdings has fallen back to 1.2x and 0.6x pre-pandemic levels in the UK and EA respectively.

Unfortunately, the recent rise in COVID-19 cases, the emergence of the omicron variant and renewed restrictions imposed by the UK and EA governments may result in these points being missed, or, worse still, the positive trends being reversed. That said, firmer economic foundations in both the UK and EA (and higher levels of vaccinations) suggest that both regions are in a stronger position to face renewed COVID challenges than they were a year ago.

Missing the point – the charts that matter

HH money flows

HHs in the UK and EA increased their money holdings significantly during the COVID-19 pandemic. Monthly flows peaked at 6x pre-pandemic levels in the UK in May 2020 (see chart above) and 2.4x pre-pandemic levels in the EA a month earlier (see chart below). At the start of 4Q21, they had moderated to 1.2x and 0.6x pre-pandemic levels in the UK and EA respectively. A key building block for a sustained economic recovery.

**Monthly HH deposit flows in the EA (EUR bn) and multiple (x) of 2019 average flow** (Source: ECB; CMMP)

Excess HH savings

In aggregate, and as a result, HHs have built up excess savings in the form of bank deposits of £162bn in the UK (see chart above) and €285bn in the EA (see chart below) since February 2020. These reflect a combination of forced savings (that may be released relatively quickly to support economic activity) and precautionary savings (that are unlikely to move straight into investment of consumption).

**Estimated build up of excess HH savings in the EA (EUR bn)** (Source: CMMP estimates)

As noted back in May (see “More bullish on UK consumption”) and confirmed by the ECB in August 2021 (see “Economic Bulletin, Issue 5”). The majority of these accumulated savings have accrued to HHs that already have sizeable savings, have higher incomes, and are older. Such HHs typically spend less from any extra savings they accumulate i.e. they have relatively low marginal propensities to consume. The release of these excess savings is likely to be only partial and gradual, therefore.

Impact on monetary aggregates

**M1 as a percentage of M3 in the UK and EA** (Source: BoE; ECB; CMMP)

HH behaviour had a marked impact on money supply dynamics during the pandemic with narrow money (M1) representing an ever-larger share of broad money (M3) in both the UK and EA (see chart above). As an example, overnight deposits contributed 6.8ppt to the total EA broad money growth of 7.6% in October 2021 alone (see chart below).

**Contribution of M1 (ppt) to growth rate in EA M3 (% YoY)** (Source: ECB; CMMP)

This matters because the expansion of broad money during the pandemic reflected the deflationary force of HHs increasing their savings and delaying consumption. Money sitting in overnight deposits contributes to neither growth nor inflation.

HH demand for consumer credit

**Growth rates in consumer credit in the UK and EA (% YoY)** (Source: BoE; ECB; CMMP)

Annual growth rates in consumer credit reached a low point in February 2021 in both the UK (-10% YoY) and the EA (-3% YoY). The rate of decline has narrowed subsequently to -1.0% in the UK in October. In the EA, annual growth rates turned positive two months later in April 2020 (see chart above).

**Monthly consumer credit flows in the UK (£ bn) and EA (EUR bn)** (Source: BoE; ECB; CMMP)

More importantly, monthly flows of consumer credit have been positive for the past six months and reached their highest levels YTD in both the UK (£0.7bn) and EA (€2.7bn) respectively (see chart above).

Conclusion

A moderation in monthly HH money flows and a recovery in demand for consumer credit represent important foundations for a sustained recovery in the UK and the EA. The rise in COVID-related risks comes at a very delicate and unfortunate time, therefore, for the recovery in both regions. It remains too early to say whether recent events will reverse these dynamics in a meaningful manner. The positive news is that firmer economic foundations in both the UK and EA suggest that both regions are in a stronger position to face these challenges than they were a year ago.

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

“Not what the doctor ordered”

Rising UK COVID-19 risks come at an unfortunate time

The key chart

**Trends in monthly HH money flows (£bn) compared to 2019 average monthly flows** (Source: BoE; CMMP)

The key message

The rise in COVID-19 cases and the discovery of the new Omicron variant come at a delicate and unfortunate time for the UK economic recovery (and associated recovery trades).

According to the Bank of England’s latest “Money and Credit” release for October 2021, monthly household money flows were moderating and demand for consumer credit was recovering at the start of 4Q21 – positive trends in two of our three key signals for 2021. So called “faster indicators” such as credit and debit card payments also indicate that positive trends continued into mid-November 2021.

There is never a good time for COVID-related risks to be rising, but it is particularly unfortunate that the threat of renewed uncertainty and restrictions on economic activity has coincided with an apparent inflexion point in the messages from the UK money sector.

Not what the doctor ordered in either a literal or metaphorical sense.

Not what the doctor ordered

The rise in COVID-19 cases and the discovery of the new Omicron variant come at a delicate and unfortunate time for the UK economic recovery and associated recovery trades.

**COVID cases and deaths (7 day MVA) in the UK** (Source: UK government; CMMP)

The number of people who tested positive has risen to 42, 583 according to the latest data provided on 29 November 2021. This represents an increase of 4,574 cases (12%) since the end of October 2021 (see chart above). In response to the identification of the new variant, the UK government has tightened restrictions on face coverings and entry into the UK. The booster programme for vaccines has also been accelerated. It remains too early to know if further restrictions will be required.

Why the timing is so bad

**Key signal #1: looking for a moderation in HH money flows** (Source: BoE; CMMP)

According to the Bank of England’s latest “Money and Credit” release for October 2021, monthly household money flows slowed sharply at the start of 4Q21.

These flows represent a useful proxy for household uncertainty. They peaked at £28bn (6x pre-pandemic levels) in May 2020 and again at £21bn (4x pre-pandemic levels) in December 2020. Note that money flows combine forced and precautionary elements of household savings. During periods of “lockdown” (see black bars in chart above), they averaged 4x their pre-pandemic levels reflecting the added impact of forced savings. Between lockdowns and since lockdowns they have averaged 2x their pre-pandemic levels.

Monthly flows fell from £9bn (2x pre-pandemic levels) in September 2021 to £5bn (1.2x pre-pandemic levels) in October 2021, the lowest monthly flow since February 2020.

**Key signal #2: looking for a recovery in consumer credit demand (£bn LHS, % YoY RHS)** (Source: BoE; CMMP)

UK households borrowed £0.7bn in consumer credit in October 2021, the strongest net borrowing since July 2020 (see chart above). Monthly flows have been positive since April 2021 – seven consecutive months of positive net borrowing. The majority of this borrowing (£0.6bn) was additional borrowing on credit cards, which was also the strongest since July 2020 (£0.9bn).

The annual growth rate in consumer credit remains negative, however (green line in chart above). That said, the YoY growth rate has narrowed to -1.0% in October from -1.7% in September and the low of -9.1% in January 2021.

**Credit and debit card payments (7d rolling average) in aggregate and on delayable goods in relation to pre-pandemic levels** (Source: ONS; CMMP)

So called “faster indicators” such as credit and debit card payments also indicate that these positive trends continued into mid-November 2021. After a sharp recovery in payments in March and April 2021 (following the easing of restrictions) momentum slowed in 2Q21 and 3Q21. Aggregate card payments rebounded in November, however, to reach 103% of pre-pandemic levels (see chart above).

**The build up in excess HH savings (£bn) during the COVID-19 pandemic** (Source: BoE; CMMP estimates)

Spending on “delayable” goods such as clothing and furniture has also recovered to 104% of pre-pandemic levels during November. This matters because spending on delayable goods is a useful indicator regarding the extent to which the £160bn in excess savings built up during the pandemic is returning to the economy via household consumption. The evidence to date is that while the build up of excess savings has slowed, this cash has yet to be spent (see chart above). A positive note to carry into the new year.

Conclusion

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

“A return to abnormality”

Looking behind the OBR’s forecasts of improving UK government finances

The key chart

The key message

The OBR’s forecasts of a rapid improvement in UK government finances (the good news) assume unusual behaviour on the part of the UK private sector and the RoW and imply a “return to the abnormality” of sustained domestic UK deficits counterbalanced by significant and persistent current account deficits (the bad news). Viewed from a sector balances perspective, the risks appear tilted to the downside ie, government finances may not recover as quickly as forecast.

The OBR published its latest “Economic and fiscal outlook” on Wednesday, 27 October 2021. The Office recognised the positive impact of the UK government’s fiscal response in protecting household and corporate incomes during the pandemic and through 2021. Looking further forward, the OBR forecasts a rapid improvement in the government’s finances, with borrowing falling back below £100bn next year and stabilising around £44bn (<2% of GDP) in the medium term.

The forecasts assume certain behaviours from the other economic sectors, namely the domestic private sector (households and corporates) and the RoW. Under the latest forecasts, the UK household sector, which is typically a net saver, shifts (unusually) to a net deficit position over the forecast period. Given the high level of existing debt, this requires HHs to sustain historically low savings ratios of c.5%. The NFC sector, which is typically a net borrower, returns to a deficit position in 2Q22 and then runs relatively high deficits of c.3% of GDP over the rest of the period. To offset these twin domestic deficits, the RoW runs equal and historically high counterbalancing surpluses vis-à-vis the UK.

In short, the forecast improvements in UK government finances rely on dynamic adjustments by other economic sectors and unusual patterns of behaviour beyond that. This suggests obvious risks that the forecasts will not be met. Furthermore, the assumed end-result is one where sustained, twin domestic deficits are counterbalanced by “significant and persistent current account deficits. The OBR describes this as a “return to more normal levels”. CMMP analysis suggests it is anything but.

“Returning to abnormality”

The OBR published its latest “Economic and fiscal outlook” on Wednesday, 27 October 2021. The outlook sets out the Office’s forecasts for the economy and public finances to 2026-27 and provides an assessment of whether the Government is likely to achieve its fiscal targets.

**The impact of COVID on UK sectoral net lending postions – % GDP, rolling annual average** (Source: OBR; CMMP)

The OBR recognised the positive impact of the UK government’s fiscal response in ensuring that household (HH) and corporate (NFC) incomes did not fall “nearly as much as this expenditure or output” during the pandemic.

Government net borrowing rose to 12.5% of GDP in 2020, to pay for the fiscal support (see chart above). The HH net surplus rose to 7.8% of GDP, versus a 1Q04-1Q21 average of 2.5%. The NFC deficit moved into balance versus a 1Q04-1Q21 average deficit of -0.8% of GDP. Hence, the private sector’s net surplus rose to 7.8% of GDP versus a 1Q04-1Q21 average of 1.7% of GDP. These imbalances have persisted into 2021 as restrictions and support remained in place, albeit to a lesser degree.

**UK public sector net lending – % GDP, rolling annual average** (Source: OBR; CMMP)

Looking forward, the OBR forecasts a rapid improvement in the UK government’s financial position (see chart above, which compares the latest forecasts with the previous version), with borrowing falling “back below £100bn next year, declining more slowly thereafter to stabilise at around £44bn (1.5% of GDP) in the medium term.” Such and improvement would be sufficient for Rishi Sunak, the Chancellor of the Exchequer, to meet his fiscal target of getting “underlying debt falling as a share of GDP by the third year of our forecast (2024-25)”.

Domestic government balance + domestic private balance + foreign balance (must) = zero

These forecasts assume certain behaviours from the other economic sectors, namely the domestic private sector and the RoW. Recall that, from national accounting principles (see identity above), we know that the deficits run by one or more economic sectors must equal surpluses run by other sector(s).

**UK household sector net lending – % GDP, rolling annual average** (Source: OBR; CMMP)

Over the forecast period, the UK household sector, which is typically a net saver, shifts (unusually) to a net borrowing position. The OBR expects the HH net surplus to peak at 10% GDP in 1Q21, fall to 5.7% of GDP by 4Q21 and then (unusually) move into deficit by 4Q22 and for much of the forecast period out to 1Q27. Note that for any sector to run a deficit it must either increase its borrowing and/or reduce its accumulation of net financial assets.

**UK HH and NFC debt ratios – % GDP** (Source: BIS; CMMP)

Given the high level of HH debt, this requires HHs to sustain historically low savings ratios. At the end of 1Q21, the UK HH debt ratio was 91% of GDP, 6ppt above the BIS threshold limit and only 5ppt below its all-time high (see chart above). This suggests that HH are unlikely to increase borrowing levels significantly over the period.

Unsurprisingly, therefore, the OBR forecasts place a greater emphasis on HH savings. First, they assume that HHs will spend c.5% of the excess savings built up during the pandemic, a reasonable assumption. Second, and following on from this, they assume that the HH savings ratio will fall rapidly and stabilise at or around historic lows of c.5%, a more aggressive assumption (see chart below). History suggests that the risks to these assumptions lie clearly to the downside.

**Historic and forecast HH savings ratio** (Source: OBR; CMMP)

The NFC sector, which is typically a net borrower, returns to a deficit position in 2Q22 and then runs relatively high deficits of c.3% of GDP over the rest of the period (see chart below). This compares with a 1Q04-1Q21 average deficit of just under 1% of GDP. Again, given the current level of NFC borrowings the risks to these forecasts and to the level of NFC investment appear tilted to the downside.

**UK non-financial corporation sector net lending – % GDP, rolling annual average** (Source: OBR; CMMP)

To offset these twin domestic deficits, the RoW runs equal and historically high counterbalancing surpluses vis-à-vis the UK. The net surplus of the RoW is forecast to increase fro 3.3% of GDP currently (in-line with historic average) to 5.3% in early 2023 and then stabilise at c.4.5% for the rest of the forecast period. In other words, the UK is assumed to be increasingly reliant on the RoW as a net lender.

**RoW sector net lending – % GDP, rolling annual average** (Source: OBR; CMMP)

Conclusion

The forecast improvements in UK government finances rely on dynamic adjustments by other economic sectors and unusual patterns of behaviour beyond that. This suggests obvious risks that the forecasts will not be met.

Furthermore, the assumed end-result is one where sustained, twin domestic deficits are counterbalanced by “significant and persistent current account deficits. The OBR describes this as a “return to more normal levels”. CMMP analysis suggests it is anything but.

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

“Neither usual, nor sustainable”

What to look for in the OBR’s “Economic and Fiscal Outlook”

The key chart

**Actual and OBR forecasts for UK private and public sectoral net lending (% GDP)**
(Source: OBR; CMMP)

The key message

On Wednesday this week (27 October 2021), the OBR will publish its latest “Economic and fiscal outlook”. Among the 200+ pages of detailed analysis and forecasts, one page and one chart are key – “sectoral net lending” (typically around page 70!). This examines the impact of expected income and expenditure of the three economic sectors (private, public and RoW) for the path of each sector’s net lending to, or borrowing from, the others. A core element of CMMP analysis.

The previous outlook (March 2021) assumed that the two domestic sectors would return to running simultaneous net financial deficits in 2022 and described this situation as “more usual.” Of course, this is only possible if the RoW runs a compensating net financial surplus at the same time (ie current account surplus vis-à-vis the UK).

In short, existing official forecasts assume persistent and significant fiscal and current account deficits between 2022 and 2026. From a CMMP perspective, this is neither usual nor sustainable. Hence our attention will naturally focus on any revisions to these assumptions. Watch this space…

Neither usual, not sustainable

The OBR will publish its “Economic and fiscal outlook” (EFO) for the UK on Wednesday October 2021. The EFO sets out the Office’s forecasts for the economy and the public finances and provides an assessment of whether the Government is likely to achieve its fiscal targets. From a CMMP perspective, the key section is the one page summary of sectoral net lending. Specifically, the impact of expected income and expenditure of different economic sectors for the path of each sector’s net lending to, or borrowing from, the others.

For background, see “Everyone has one”

In the previous EFO (March 2021), the OBR argued that, “Over the medium term, sectoral lending positions return to more usual levels. As can be seen from the key chart above, this assumed that the two domestic sectors would both be running simultaneous net financial deficits (ie, both spending more than they earn). Note that, in the case of a simple two-sector economy, it would be impossible for the private and public sectors to be running deficits at the same time.

For background, see “Imbalances and dependencies”

**Actual and OBR forecasts for UK private and public and RoW sectoral net lending (% GDP)**
(Source: OBR; CMMP)

Of course, in practice the two domestic sectors are linked economically to foreign FIs, NFCs, HHs and governments, collectively termed the rest-of-the-world (RoW). From this, we can see that the previous OBR forecasts assume that the RoW would run compensating net financial surpluses (current account surpluses) vis-à-vis the UK domestic sectors.

For background, see “Where is the value…?”

In short, existing forecasts assume significant and persistent fiscal and current account deficits from 2022-2026. From a CMMP perspective, this is neither usual nor sustainable. Hence, our attention will naturally turn to the revised assumptions this week…

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

“Bashing the plastic?”

UK card payments trending below pre-pandemic levels

The key chart

**Aggregate card payments in relation to pre-pandemic levels** (Source: ONS; CMMP)

The key message

Despite accumulating close to £160bn in excess savings during the pandemic, UK households (HHs) appear reluctant to “bash their plastic”.

All categories of credit and debit card payments – delayable, social, staples and work-related – have recovered strongly during 2021. Unsurprisingly, the biggest increases have occurred in social and work-related payments with the easing/lifting of restrictions. Aggregate payments peaked at 106% of pre-pandemic levels on 5 May 2021, however, and have been trending slightly below pre-pandemic levels ever since.

HHs have been spending more on getting to work recently than on delayable items such as clothing and food, with the recent fuel shortages creating an additional, albeit temporary spike, in the former type of spending.

Significantly, delayable spending peaked at 121% of pre-pandemic levels a week after the lifting of restrictions on the opening of non-essential stores on 12 April 2021 and have fallen back to 92% of pre-pandemic levels now. This matters because spending on delayable goods is a useful indicator regarding the extent to which excess savings are returning to the economy via HH consumption in a sustained fashion.

The on-going message from the money sector here is that while the direction of travel in HH consumption has been positive YTD, momentum has slowed. This is consistent with historical evidence that suggests (1) that HHs take time to respond to shocks, (2) that unanticipated increases in HH wealth tend to be saved rather than spent; and (3) that excess savings were built up by HHs with relatively low marginal propensities to consume.

The six charts that matter

**CMMP estimates for excess HH savings built up during the pandemic** (Source: ONS; CMMP)

Despite accumulating close to £160bn in excess savings during the pandemic (see chart above), UK households (HHs) appear reluctant to “bash their plastic”.

**Card payments in relation to pre-pandemic levels by spending category** (Source: ONS; CMMP)

All categories of credit and debit card payments – delayable, social, staples and work-related – have recovered strongly during 2021 (see chart above). Unsurprisingly, the biggest increases have occurred in social and work-related payments with the easing/lifting of restrictions (see chart below).

**Change (ppt) in relative payments since end-2000 by category** (Source: ONS; CMMP)

Aggregate payments peaked at 106% of pre-pandemic levels on 5 May 2021, however, and have been trending slightly below pre-pandemic levels ever since (see chart below).

**Aggregate card payments in relation to pre-pandemic levels since end-2020** (Source: ONS; CMMP)

**Payments on delayable and work-related goods in relation to pre-pandemic levels** (Source: ONS; CMMP)

Significantly, delayable spending peaked at 121% of pre-pandemic levels a week after the lifting of restrictions on the opening of non-essential stores on 12 April 2021 and have fallen back to 92% of pre-pandemic levels now (see chart below). This matters because spending on delayable goods is a useful indicator regarding the extent to which excess savings are returning to the economy via HH consumption.

**Aggregate and delayable goods payments in relation to pre-pandemic levels** (Source: ONS; CMMP)

Conclusion

The on-going message from the money sector here is that, while the direction of travel in HH consumption has been positive YTD, momentum has slowed. This is consistent with historical evidence that suggests (1) that HHs take time to respond to shocks, (2) that unanticipated increases in HH wealth tend to be saved rather than spent; and (3) that excess savings were built up by HHs with relatively low marginal propensities to consume.

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

“Note to Rishi”

It’s the economy, not the budget, that has to balance

The key chart

UK financial sector balances (4Q rolling averages, £bn) (Source: ONS; CMMP)

The key message

Note to Rishi – a “pragmatic” and “responsible” fiscal outcome for the UK is one that delivers a balanced economy not a balanced budget.

Pre-COVID, the UK was running large and persistent sector imbalances and was increasingly reliant on the rest-of-the-world (RoW) as a net lender. The HH sector, which plays a critical role in the UK economy (FCE/GDP) and bank lending, had been funding consumption by dramatically reducing its savings rate and accumulation of net financial assets and was poised to disappoint.

In the face of the pandemic, the UK private sector shifted to an unprecedented net lending position of 21% GDP, 13ppt above the 4Q09 post-GFC peak. The HH sector alone moved from a net borrowing position of 0.4% GDP in 3Q19 to a net lending position of 15% GDP in 2Q20 as the HH savings ratio rose to a record high of 23% GDP. Extraordinary and co-ordinated responses to these extraordinary times came from the UK government and the Bank of England, including extensions to the furlough scheme and increases in the central bank’s buying programme. The responses were both timely and appropriate. The UK government increased its net borrowing positions to 25% GDP in 2Q20 and 14% in 3Q20.

According the latest ONS statistics, the net lending position of the UK private sector was still 6% GDP at the end of 2Q21, down from 10% in the previous quarter but still well above the LT (pre-COVID) average of just under 1% GDP. Both non-financial and financial corporations increased their net lending positions in 2Q21 to 1% of GDP respectively. In contrast, the HH’s net lending position fell from 9% GDP (£52bn) in 1Q21 to 5% GDP (£27bn) in 2Q driven by a recovery in spending. Note, however, that it remains double its LT average. On a positive note, the HH savings rate fell to 12% in 2Q21 from 18% in 1Q21 (the second highest rate on record).

The recent messages from the UK money sector suggest that HHs remain uncertain with monthly HH deposit flows rising again in August to double their pre-pandemic levels and demand for consumer credit remaining weak. So-called “faster-indicators” also indicate that credit and debit card payments remain below their pre-pandemic levels.

As the UK emerges from the COVID pandemic, large sector imbalances remain but in very different ways to the pre-COVID period. The private sector continues to disinvest, HHs remain uncertain and credit demand (ex-mortgages) remains subdued. UK HHs have built up c£160bn of excess savings during the pandemic but history suggests that (1) they take time to respond to shocks and (2) that unanticipated increases in wealth tend to be saved rather than spent. The co-ordinated fiscal and monetary policy response to the pandemic was timely and appropriate but it remains premature to be discussing significant fiscal adjustments and/or an end to “bigger government”.

Contrary to some of the current political rhetoric, budget outcomes are inappropriate goals in themselves. The correct budget outcome is the one that delivers a balanced economy, not a balanced budget.

“Note to Rishi” – the charts that matter

**UK financial sector balances – RoW deliberately shaded out!** (Source: ONS; CMMP)

Pre-COVID, the UK was running large and persistent sector imbalances and was increasingly reliant on the rest-of-the-world (RoW) as a net lender (see chart above). The HH sector, which plays a critical role in the UK economy (FCE/GDP) and bank lending, had been funding consumption by dramatically reducing its savings rate and accumulation of net financial assets and was poised to disappoint (see chart below).

**Poised to disappoint – HH gross savings and savings ratio** (Source: ONS; CMMP)

**Private sector net lending position as % GDP** (Source: ONS; CMMP)

In the face of the pandemic, the UK private sector shifted to an unprecedented net lending position of 21% GDP, 13ppt above the 4Q09 post-GFC peak (see chart above). The HH sector alone moved from a net borrowing position of 0.4% GDP in 3Q19 to a net lending position of 15% GDP in 2Q20 as the HH savings ratio rose to a record high of 23% GDP (see chart below).

**A record high in HH savings** (Source: ONS; CMMP)

Extraordinary and co-ordinated responses to these extraordinary times came from the UK government and the Bank of England, including extensions to the furlough scheme and increases in the central bank’s buying programme. The responses were both timely and appropriate (see chart below). The UK government increased its net borrowing positions to 25% GDP in 2Q20 and 14% in 3Q20.

**UK policy responses from a sector balances perspective** (Source: ONS; CMMP)

**Breakdown of private sector net financial balances** (Source: ONS; CMMP)

In contrast, the HH’s net lending position fell from 9% GDP (£52bn) in 1Q21 to 5% GDP (£27bn) in 2Q driven by a recovery in spending. Note, however, that it remains double its LT average (see chart below). On a positive note, the HH savings rate fell to 12% in 2Q21 from 18% in 1Q21 (the second highest rate on record). The recent messages from the UK money sector suggest that HHs remain uncertain with monthly HH deposit flows rising again in August to double their pre-pandemic levels and demand for consumer credit remaining weak. So-called “faster-indicators” also indicate that credit and debit card payments remain below their pre-pandemic levels.

**HH sector net lending position** (Source: ONS; CMMP)

Conclusion

The co-ordinated fiscal and monetary policy response to the pandemic was timely and appropriate but it remains premature to be discussing significant fiscal adjustments and/or an end to “bigger government”. Contrary to some of the current political rhetoric, budget outcomes are inappropriate goals in themselves. The correct budget outcome is the one that delivers a balanced economy, not a balanced budget.

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

“(Re-)fuelling challenges II”

Synchronised money cycles and messages from the UK and EA

The key chart

Broad money growth (% YoY) in UK and the euro area (Source: BoE, ECB; CMMP)

The key message

UK and euro area (EA) money cycles remain highly synchronised with the message from both region’s money sectors remaining one of “slowing momentum”.

At the start of 2021, I highlighted three key signals among these messages: are monthly HH deposit flows moderating; is consumer credit recovering; and are money and credit cycles re-synching with each other? The context here being that narrow money (M1) drove the expansion of broad money (M3) in both regions during the pandemic, reflecting the DEFLATIONARY forces of heightened uncertainty, increased (forced and precautionary) savings, reduced consumption and relatively subdued demand for credit.

While monthly flows of HH deposits are well below their respective peaks, they rose in both regions in August, notably in the UK where August’s flow was 2x pre-pandemic levels. Money sitting idly in overnight deposits contributes to neither growth nor inflation. Household uncertainly remains elevated and consumption muted (see also “Delaying the delayable”). Monthly consumer credit flows remain subdued in August and YoY growth rates were -2.4% in the UK and flat in the EA. Money and credit cycles remain out-of-synch with each other, presenting challenges to policy makers and investors alike and reminding us not to confuse current money cycles with previous versions. Furthermore, not only is private sector credit demand relatively subdued, it is also increasingly driven by FIRE-based lending (largely mortgages) rather than more productive COCO-based lending (largely NFC and consumer credit).

Economies and markets have benefitted from changing policy mixes that have been necessary and appropriate. Momentum in the key drivers of a sustained recovery is slowing, however, and further refuelling is required as we enter 4Q21.

Four charts that matter

**Monthly HH deposit flows as a multiple of average 2019 monthly flows** (Source: BoE; ECB; CMMP)

While monthly flows of HH deposits are well below their respective peaks, they rose in both regions in August, notably in the UK where August’s flow was 2x pre-pandemic levels (see chart above). Money sitting idly in overnight deposits contributes to neither growth nor inflation. Household uncertainly remains elevated and consumption muted.

**Annual growth in UK and EA consumer credit** (Source: BoE; ECB; CMMP)

Monthly consumer credit flows remain subdued in August and YoY growth rates were -2.4% in the UK and flat in the EA (see chart above).

**Lending growth minus money supply growth in the UK and EA** (Source: BoE; ECB; CMMP)

Money and credit cycles remain out-of-synch with each other (see chart above), presenting challenges to policy makers and investors alike and reminding us not to confuse current money cycles with previous versions.

**Growth rates in private sector credit by type** (Source: BoE; ECB; CMMP)

Furthermore, not only is private sector credit demand relatively subdued, it is also increasingly driven by FIRE-based lending (largely mortgages) rather than more productive COCO-based lending (largely NFC credit and consumer credit).

Conclusion

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

“Delaying the delayable”

Faster indicators support a “slowing UK momentum” narrative

The key chart

**Work-related and delayable card payments versus pre-pandemic levels** (Source: ONS; CMMP)

The key message

UK households are delaying spending on so-called “delayable goods” such as clothing and furniture. This matters because this form of spending is a useful indicator of the extent to which the c. £150bn excess savings built up during the pandemic is returning to the UK economy via consumption in a sustained fashion.

Delayable purchases recovered strongly following the re-opening of non-essential stores (12 April) to reach 122% (19 April) and 112% (5 May) of pre-pandemic levels. The latest ONS data release indicates that they fell back to 86% of pre-pandemic levels in the week to 9 September 2021, however (see chart above).

While all forms of credit and debit card spending have recovered from their 2021 lows, only spending on staples and work-related purchases are above pre-pandemic levels (see chart below).

In short, households are spending more in returning to work but the wider message from faster-indicators supports a “slowing UK momentum” narrative.

**Credit and debit card payments versus pre-pandemic levels by type** (Source: ONS; CMMP)

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