#strategy – Page 6 – Chris Mallin Macro Perspectives

“Update required – Part II”

Five economies to watch – elevated private sector debt risks

The key chart

**Trends in selected economies’ private sector debt ratios (% GDP)**
(Source: BIS; CMMP)

The key message

While the private sector is deleveraging (passively) at the global level, elevated risks remain in Sweden, France, Korea, China and Canada. Unfortunately, these risks may be overlooked in a world that sees public sector debt as a problem but largely ignores private sector debt. That would be a mistake.

Why focus on Sweden, France, Korea, China and Canada?

First, their levels of private sector indebtedness exceed the “peak-bubble” level seen in Japan (214% GDP, 4Q94) and, in the cases of Sweden and France, the peak-bubble level seen in Spain (227% GDP, 2Q10) too. Potential warning sign #1.

Second, in contrast to other economies that exhibit high levels of private sector indebtedness (eg, the Netherlands, Denmark, and Norway) affordability risks are also elevated in these five highlighted economies. Their debt service ratios are not only high in absolute terms (>20% income), they are also elevated in relation to their respective 10-year, average affordability levels. Potential warning sign #2.

Note, finally, that among these five economies, Sweden, Korea and Canada have over-indebted NFC and HH sectors, while the risks in France and China relate more, but not exclusively, to their NFC sectors. When it comes to private sector debt dynamics, the world is far from a homogenous place…

Update required – Part II

**Trends in global private sector debt ($tr) and debt ratio (% GDP, RHS)**
(Source: BIS; CMMP)

Global private sector indebtedness (debt % GDP) fell between 2Q21 (172% GDP) and 2Q22 (160% GDP) according to the latest BIS data release (5 December 2022).

This was a form of passive deleveraging ie, total debt increased over the period (from $142tr to $143tr) but at a slower pace that nominal GDP (see chart above). Both corporate (NFC) and household (HH) debt ratios fell over the period.

**Private sector debt ratios (% GDP) as at the end of 2Q22**
(Source: BIS; CMMP)

While China ($39tr) and the US ($38tr) collectively account for 54% of total private sector debt, they rank only #9 and #22 in terms of indebtedness. As noted many times before, debt and indebtedness are not the same things.

The most indebted private sectors among the BIS reporting economies are Luxembourg, Hong Kong, Switzerland, Sweden, the Netherlands, France, Denmark, South Korea, China, Canada. Norway and Singapore. In each case, private sector credit exceeded 200% of GDP at the end of 2Q22 (see chart above).

**HH debt ratios (% GDP) plotted against NFC debt ratios for 2Q21 and 2Q22**
(Source: BIS; CMMP)

This highlighted group of relatively indebted private sectors are far from homogenous, however:

Luxembourg, Hong Kong, Singapore and Switzerland have unique “financial roles” that differentiate them from the other economies, for example;
Among the remaining nations only China and South Korea experienced increases in both NFC and HH indebtedness between 2Q21 and 2Q22;
All of them have relatively indebted NFC sectors (NFC debt >90% GDP), but Switzerland, the Netherlands, Denmark, Korea and Canada also have “overly-indebted” HH sectors (HH debt > 85% GDP)
In contrast, France, China, Norway and Singapore have “overly indebted” NFC sectors, but less elevated HH debt ratios

Returning to the theme of history repeating itself and/or rhyming, I have chosen to highlight private sector dynamics in Sweden, France, South Korea, China and Canada for two reasons – their level of private sector indebtedness in relation to trends observed during debt bubbles in Japan and Spain, and their associated and elevated affordability risks.

Private sector debt levels peaked at 214% GDP in Japan and 227% GDP in Spain at the height of their respective private sector debt bubbles (in 4Q94 and 3Q10 respectively).

At the end of 2Q22, private sector debt levels in Sweden (269% GDP) and France (231% GDP) exceeded the peak levels in both Spain and Japan while the private sector debt levels in Korea (222% GDP), China (220% GDP) and Canada (220% GDP) exceeded the peak level in Japan but remained below the Spanish peak.

Note again that among these five economies, Sweden, Korea and Canada have over-indebted NFC and HH sector, while the risks in France and China and relate more, but not exclusively, to their NFC sectors.

**Debt service ratios – deviation from 10Y ave versus current level as at end 2Q22**
(Source: BIS; CMMP)

Private sector debt service ratios in Sweden, Canada, South Korea, France and China are not only high in absolute terms (ie, > 20%), but they also exceed their 10-year average levels. In contrast, while DSRs in the Netherlands, Norway and Denmark appear relatively high in absolute terms, there are below their respective 10-year averages. Note that due to comparability issues between DSR calculations, the BIS prefers to focus on deviations from LT averages when assessing affordability risks.

Conclusion

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

“Update required – Part I”

History rhymes – but this chart still needs refreshing

“The key chart”

**Trends in Japanese, Spanish and Chinese private sector debt % GDP ratios** (Source: BIS; CMMP)

The key message

I published this chart for the first time in 2017 to ask whether history was repeating itself in terms of private sector indebtedness – was China following in the footsteps of Japan and Spain?

It was also an opportunity to flag the rapid rise in household (HH) debt in China (see also, “Too much, too soon“), and to highlight the risks associated with rapid rates of growth in debt (see also, “Beyond the headlines“)

These trends and risks are understood better today (and the same chart has been reproduced many times by different people) – but the chart is in urgent need of an update. The reasons will be revealed later today when the BIS releases its 2Q22 update of global credit…

“Steady as she slows – Part III”

EA and UK money sectors sending cautious consumption messages

The key chart

**Monthly consumer credit flows as a multiple of pre-pandemic average flows** (Source: BoE; ECB; CMMP)

The key message

Monthly consumer credit flows in the euro area (EA) and the UK bounced slightly in October 2022 but momentum appears to be weakening. The regions’ money sectors are sending cautious messages about the outlook for consumption and growth.

**Monthly EA consumer credit flows as a multiple of pre-pandemic average flows** (Source: ECB; CMMP)

In the EA, the monthly flow of consumer credit was €2.4bn in October 2022, up from €1.9bn in September 2022. (Note that September was revised down from €4.8bn previously). This flow was only 0.7x the pre-pandemic average of €3.4bn. The 3m MVA of monthly flows was €1.4bn, only 0.4x its pre-pandemic average. Smoothed monthly flows have yet to recover to pre-pandemic levels, confirming that risks to EA economic growth lie in the lack of demand for consumer credit.

Monthly UK consumer credit flows as a multiple of pre-pandemic average flows (Source: BoE; CMMP)

In the UK, the monthly flow of consumer credit was £0.8bn in October 2022, up from £0.6bn in September 2022. This flow was only 0.6x the pre-pandemic average of £1.2bn, however. The 3m MVA of monthly flows was £0.9bn, only 0.7x its pre-pandemic average. Last month I suggested that the risks to the UK economic outlook lay in demand for consumer credit stalling. This remains the case.

In the face of falling real disposable incomes, EA and UK households have the option to reduce consumption, reducing their rates and/or stock of savings, and/or borrow more.

Given that excess savings typically accrue to HHs with relatively low marginal propensities to consume, the flow of consumer credit becomes an important indicator in terms of the relative strength of the EA and UK economies and the risks to future growth.

With momentum slowing here, the downside risks are mounting in both regions.

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

“Appropriate health warnings?”

The OBR adds a “sectoral net lending” perspective, but the message stays the same

The key chart

**Trends and forecasts for UK sector financial balances (% GDP)** (Source: OBR; CMMP)

The key message

The OBR provided more details behind their latest forecasts for the UK economy this week, including a “sectoral net lending” perspective. The message remains the same, however (or even slightly worse).

Their starting point was an unattractive one. Their end point – an unsustainable world of prolonged, twin domestic deficits counterbalanced by significant current account deficits (ie, RoW surpluses) – is no better.

The good news for Jeremy Hunt, the Chancellor of the Exchequer, is that the net financial deficit of the UK public sector is forecast to fall sharply and to trend at c2-3% of GDP throughout their forecast period.

The bad news for UK households is that their net financial position is forecast to fall from its recent (and typical) surplus to sustained deficits of between 0.1% and 0.4% GDP. In short, the UK is set to become a nation of non-savers with households also spending more of their income on servicing their debt.

The lack of appropriate health warnings and the implied structural shift in risk away from the public sector to the private sector here reflects either flaws in macro thinking and policy-making and/or the heavy hand of reverse engineering. Neither are good news.

Appropriate health warnings

The OBR provided more details behind its latest economic forecasts this week (24 November 2022). This includes a “sectoral net lending” perspective (see chart below), an important framework that links all domestic economic sectors with each other and with the RoW (and represents a core element of CMMP Analysis).

Recall that the three core sectors in a given economy – the private, public and RoW sectors – can be treated as having income and savings flows over a given period. If a sector spends less than it earns it creates a budget surplus. Conversely, if it spends more that it earns it creates a budget deficit. A surplus represents a flow of savings that leads to an accumulation of financial assets while a deficit reduces net wealth. If a sector is running a deficit it must either reduce its stock of financial assets or it must issue more IOUs to offset the deficit. If the sector runs out of accumulated financial assets, it has no choice other than to increase its indebtedness over the period it is running the deficit. In contrast, a sector that runs a budget surplus will be accumulating net financial assets. This surplus will take the form of financial claims on at least one other sector.

**Trends and forecasts for UK public sector financial balances – note reverse scale!**
(Source: OBR; CMMP)

The good news for Jeremy Hunt, the Chancellor of the Exchequer, is that the net financial deficit of the UK public sector is forecast to fall from its COVID-19 peak of £123bn (26% GDP) in 2Q20 to a deficit of £59bn (9% GDP) at the end of 4Q22. Beyond that the OBR expects the net financial deficit to trend at around £20bn (2-3% GDP) for the rest of the forecast period (see chart above, note reverse scale!).

**Trends and forecasts for UK HH financial balances** (Source: OBR; CMMP)

The bad news for UK households is that their net financial position is forecast to fall from a record surplus of £86bn (18% GDP) in 2Q20 to a deficit of £7bn (-1.2% GDP) at the end of 3Q22. Beyond that, the OBR forecasts sustained HH deficits of between £2-3bn (-0.1% to -0,4% GDP) for the rest of the forecast period (see chart above).

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

As above, if a sector is running a deficit it must either reduce its stock of financial assets or it must issue more IOUs to offset the deficit ie, borrow more.

As noted before, the OBR assumes that the UK will become a nation of non-savers. or nearly non-savers, throughout their forecast period.They forecast that the savings ratio will fall from its “very high lockdown-induced peak” of 24% in mid-2020 to a low of zero per cent in 2023 (see chart above). Beyond that, they assume that the savings ratio will settle “at around half a per cent from 2025 onwards.” This will allow some HHs to cushion the impact of inflation on consumption but will also result in higher levels of financial inequality (see “Financial inequality and debt vulnerability”).

**Trends and forecast in HH debt service costs and debt service ratio** (Source: OBR; CMMP)

The OBR’s forecasts also highlight rising debt servicing risks for the household sector. The debt servicing cost is forecast to rise from £60bn at the end of 4Q22 (3.8% of disposable income) to £107bn at the end of 4Q23 (6.6% of disposable income) and £125bn at the end of 4Q24 (7.5% of disposable income). Beyond that, the debt service ratio is assumed to stabilise at around 7.5% of disposable income below the 9.7% level seen at the time of the GFC (see chart above).

Conclusion

To return to an enduring CMMP analysis theme – the lack of appropriate health warnings and the implied structural shift in risk away from the public sector to the private sector here reflects either flaws in macro thinking and policy-making and/or a heavy hand of reverse engineering. Neither are good news.

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

“Icy shower for UK households”

A downbeat OBR outlook for HHs and UK growth

The key chart

**Forecasts for real HH disposable income** (Source: OBR; CMMP)

The key message

The OBR’s latest (and slightly abbreviated) forecasts present an icy shower for UK households (HHs) and for the overall UK growth outlook.

The OBR expects real HH disposable income – one measure of living standards – to fall by a record amount (-4.3%) in FY22-23 and for two consecutive fiscal years for the first time since the GFC. The assumed 7% cumulative reduction in living standards would wipe out all of the previous eight years’ growth.

OBR economists also expect the UK to become a nation on non-savers, or nearly non-savers, throughout their forecast period.

The combination of higher prices, rising borrowing costs, falling house prices and higher unemployment will result in a peak-to-trough fall in consumption of -2.7% between 2Q22 and 3Q23. Falling consumption and investment will lead, in turn, to a recession lasting just under a year from 3Q22.

CMMP Analysis typically assesses the OBR’s forecasts within its preferred sector balances framework (see, “Good news for Rishi, but…”). We expect more details of the OBR’s assumptions regarding sector balances to be published on 24 November 2024.

More to follow…

Icy shower for UK households

**Trends and forecasts for real HH disposable income versus pre-pandemic level**
(Source: OBR; CMMP)

The OBR expects real HH disposable income (RHDI) – one measure of living standards – to fall -4.3% in FY22-23 and -2.8% in FY23-24 (see key chart above). The decline of -4.3% would represent the largest fall since records began back in FY56-57! The -2.8% fall would represent the second largest fall!

To make matters worse, this would be only the third time that RHDI per person has fallen for two consecutive fiscal years. The last time was immediately after the GFC.

Looking further out, the forecasts assume that by FY2027-28, RHDI per person recovers to its 2021-22 level, but remains below its pre-pandemic level (see chart above).

**Trends and forecasts for HH savings ratio (% disposable income)** (Source: OBR; CMMP)

OBR economists also expect the UK to become a nation on non-savers, or nearly non-savers, throughout their forecast period.

They forecast that the savings ratio will fall from its “very high lockdown-induced peak” of 24% in mid-2020 to a low of zero per cent in 2023 (see chart above). Beyond that, they assume that the savings ratio will settle “at around half a per cent from 2025 onwards.” This will allow some HHs to cushion the impact of inflation on consumption but will also result in higher levels of financial inequality (see “Financial inequality and debt vulnerability”).

**Trends and forecasts for CPI (% YoY)** (Source: OBR; CMMP)

The OBR revised its forecast for peak inflation from 8.7% (March 2022 forecast) to 11.1% in 4Q22 (see chart above). The current forecast represents a 40-year high for UK inflation and would have been higher still (13.6%) without the reduction in utility prices that results from the EPG.

**Trends and market expectations for UK base rate** (Source: OBR; CMMP)

The UK base rate is currently at its highest level (3%) since 2008 and higher than peak market expectations back in March 2022.

Current market assumptions (which underpin the OBR forecasts) indicate that the base rate will peak at around 5% in 2H23 (see chart above), 3ppt above the March 2022 forecast. Market expectations suggest that the rate falls back from 1Q24 but remains 3ppt above the OBR’s previous forecast.

**Trends and forecasts for UK house prices (£000s)** (Source: OBR; CMMP)

The OBR expects UK house prices to fall by 9% between 4Q22 and 3Q24 (see chart above). This reflects, “significantly higher mortgage rates as well as the wider economic downturn”. OBR economists forecast that the average interest rate on the stock of outstanding mortgages peaks at 5.0% in 2H24, the highest level since 2008 and almost 2ppt above their previous forecast. Rates are forecast to fall back below 5% by the end of the forecast horizon.

**Trends and forecasts for UK unemployment rate (%)** (Source: OBR; CMMP)

UK unemployment is currently at its lowest level (3.5%) since January 1974. With vacancies remaining high and surveys indicating on-going recruitment difficulties, any rise in unemployment is likely to lag the expected fall in GDP.

The OBR forecasts that the unemployment rate will rise to 4.9% in 3Q24 (see graph above), just under 1ppt above its previous forecast. Beyond this, the OBR expects unemployment to return to its “estimated structural rate” of 4.1% by late 2027.

The OBR expects consumption to fall by 2.7% from 2Q22 to the 3Q23, before recovering in 2024 and 2025. Looking further ahead, the OBR economists assume consumption “settling at growth of around 2% a year”.

**Trends and forecasts for UK real GDP** (Source: OBR; CMMP)

Falling consumption and investment will, in turn, lead to a recession lasting just under a year from 3Q22. GDP data for 3Q22, released after their forecast closed, showed output declining 0.2%. The OBR expects a further fall in 4Q22 and for GDP to fall by 1.4% in 2023 overall (see chart above), down from the 2022 annual growth rate of 4.2%.

**Trends and forecasts for UK real GDP (4Q19 = 100)** (Source: OBR; CMMP)

CMMP Analysis typically assesses the OBR’s forecasts within its preferred sector balances framework. We expect more details of the OBR’s assumptions regarding sector balances to be published on 24 November 2024.

More to follow…

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

“Clues from consumer credit II”

An update from the US

The key chart

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

The key message

US consumer credit demand remains strong in absolute and relative terms but the growth momentum is slowing. A key signal to watch in 4Q22 and beyond…

The US has seen 25 consecutive months of positive monthly consumer credit flows since August 2020. The latest data FED data point for September 2022 (published yesterday, 7 November 2022), showed a monthly flow of $26bn (3m MVA). This was 1.8x the average pre-COVID flow of $14.8bn. Comparable multiples for the euro area and UK were 0.6x and 1.0x average pre-COVID flows respectively, highlighting one reason for the relative strength of the US recovery.

In my previous post (before yesterday’s data release), I highlighted that US monthly flows had been more than double their pre-COVID average since March 2022 and suggested that, “the risks to the US growth outlook include the sustainability of current consumer credit demand.”

September broke this trend and while it is too early to draw definitive conclusions it is important to note the slowing growth momentum since April 2022 when monthly flows peaked at $37bn (3m MVA), 2.5x the pre-COVID average (see key chart above).

A key signal for 4Q22 and beyond…

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

“Completing the transition”

The end of “pandemic-era” economics

The key chart

**Growth rate in M3 (% YoY) and contribution (ppt) of M1 and private sector credit**
(Source: ECB; CMMP)

The key message

Monetary developments in the euro area (EA) indicate a clear transition away from “pandemic-era” economics.

Growth rates in broad money (M3) recovered during 3Q22 but remained well below pandemic levels. Three important, positive developments lay behind the headline growth figures.

First, the period of heightened uncertainty and subdued demand for credit that reached a peak during the pandemic has ended.
Second, and following on from this, EA money and credit cycles are re-synching with each other as the demand from credit recovers to levels last seen in December 2008.
Third, and perhaps most importantly, the breakdown of private sector credit is shifting back towards increased demand for productive (COCO-based) lending – corporate credit is accelerating while mortgage demand is moderating slowly.

So far, so good.

Rising inflation is outweighing each of these positive developments, unfortunately.

Monetary trends adjusted from inflation, are sending very different and consistently negative messages. Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP. Each indicator is falling at an increasing rate.

If historic relationships between these variables continue, this suggests a deceleration in overall economic activity over the next quarters.

Completing the transition

Monetary developments in the euro area (EA) indicate a clear transition away from “pandemic-era” economics.

**Growth rates (% YoY) in broad (M3) and narrow (M1) money**
(Source: ECB; CMMP)

Growth rates in broad money (M3) recovered during 3Q22 but remained well below pandemic levels. M3 rose 6.3% YoY in September, up from 6.1% YoY in August and 5.7% YoY in July. Despite this, broad money growth was 6.2ppt below its 12.5% YoY January 2021 peak (see chart above).

Narrow money (M1), a key component of broad money, rose only 5.6% YoY, however, down from 6.8% YoY in both August and July. Narrow money growth was 10.9ppt below its 16.5% YoY January 2021 peak.

Behind the headline YoY growth figures lie three important, positive developments.

**Growth rate (% YoY) in M3 and contribution (ppt) of ON deposits and other components**
(Source: ECB; CMMP)

First, the period of heightened uncertainty and subdued demand for credit that reached a peak during the pandemic has ended. Recall that the hoarding of cash by HHs and NFCs, largely in the form of overnight deposits at banks, was the main driver of the spike in broad money during the pandemic (see graph above). M3 growth peaked at 12.5% YoY in January 2021. At the same time, M1 and overnight deposits grew 16.5% YoY and 17.1% YoY and contributed 11.3ppt and 10.1ppt to total broad money growth respectively.

With heightened levels of uncertainty, HHs were increasing their forced and precautionary savings. The key point here is that money sitting idly in overnight deposits at banks contributed to neither economic growth nor inflation.

**Growth rate (% YoY) in M3 and contribution (ppt) of private sector credit**
(Source: ECB; CMMP)

Note also, that at the point of maximum M3 growth, private sector credit grew only 4.5% YoY and contributed only 5.4ppt to the 12.5% YoY growth in broad money (see graph above).

Fast forward to September 2022, and private sector credit grew 6.9% YoY in September, up from 6.8% YoY in August and 6.3% YoY in July. At the end of 3Q22, private sector credit contributed 5.4ppt to the total 6.3% YoY growth rate in broad money. This represents a clear break from the monetary dynamics seen during the pandemic (see key chart above).

**Growth rates (% YoY) in M3 and private sector credit**
(Source: ECB; CMMP)

Second, and following on from this, EA money and credit cycles are re-synching with each other as the demand from credit recovers to levels last seen in December 2008.

As noted in “Don’t confuse the messages”, monetary aggregates and their counterparts move together in typical cycles. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing.

**Growth rate (% YoY) in private sector credit minus growth rate in M3**
(Source: ECB; CMMP)

The “pandemic-era” relationship between money and credit cycles was far from typical, however. In January 2021, the gap between the YoY growth rate in M3 (12.5% YoY) and private sector credit (4.5% YoY) reached a historic high of 8ppt (see chart above).

During 2021, CMMP analysis focused on this dynamic as one of the three key signals to monitor. In September 2022, private sector credit grew faster (6.9% YoY) than money supply (6.3% YoY) for the fourth consecutive month as money and credit cycles re-synched with each other.

**Trends in the outstanding stock of private sector credit (EUR bn) with breakdown between COCO-based and FIRE-based lending** (Source: ECB; CMMP)

Third, and perhaps most importantly, the breakdown of private sector credit is shifting back towards increased demand for productive (COCO-based) lending – corporate credit is accelerating while mortgage demand is moderating slowly.

Recall that the outstanding stock of loans that support production and income formation in the euro area (COCO-based loans) only recovered to the GFC period peaks in November 2021 (see chart above). Nearly all of the aggregate growth in euro area lending since the GFC has been in the form of less-productive FIRE-based lending (see “Fuelling the FIRE” and “It’s a record of sorts”).

**Growth (% YoY) in PSC and contribution (ppt) of COCO-based and FIRE-based lending**
(Source: ECB; CMMP)

In September 2022, COCO-based and FIRE-based lending both contributed 3.3ppt to the total 6.6% YoY growth in (unadjusted) private sector credit (see graph above). This contrast sharply with the situation a year earlier in September 2021 when COCO-based and FIRE-based lending contributed 0.7ppt and 2.5ppt to the total 3.2% YoY growth rate.

**Growth rates (% YoY) in mortgages and loans to NFCs**
(Source: ECB; CMMP)

Significantly, the growth rate in lending to NFCs (the largest element of COCO-based lending) grew faster (8.0% YoY) and contributed more to total lending (3.1ppt) than mortgage lending (the largest element of FIRE-based lending) which grew 5.1% YoY and contributed 2.1ppt to total lending.

So far, so good.

Rising inflation is outweighing each of these positive developments, unfortunately. Monetary trends adjusted from inflation, are sending very different and consistently negative messages.

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

Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP. Each indicator is falling at an increasing rate (see chart above). If historic relationships between the variables continue, this suggests a deceleration in overall economic activity over the next quarters.

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

“If I was the OBR…”

…I would not start from here!

The key chart

**Trends in UK sector balances (% GDP)** (Source: ONS; CMMP)

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

**Trends in domestic UK sector balances (% GDP)** (Source: ONS; CMMP)

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).

**Trends in quarterly HH inflation** (Source: ONS; CMMP)

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.

**Trends in nominal and real growth rates (% QoQ) in HH disposable income** (Source: ONS; CMMP)

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.

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

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.

**Trends in UK HH debt ratio (% GDP)** (Source: BIS; CMMP)

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.

**Sector balances assumptions from March 2022 OBR forecast** (Source: OBR; CMMP)

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.

“A significant monetary policy response”

Challenges the official outlook for HH debt vulnerability

The key chart

**Share of UK households with high, adjusted DSRs on mortgage debt** (Source: BoE; CMMP)

The key message

A “significant monetary policy response” from the Bank of England poses an equally significant risk to the Bank’s relatively sanguine view of household debt affordability and financial stability, expressed less than 90 days ago.

In its July 2022 “Financial Stability Review” (FSR), the Bank of England forecast that the share of UK households with high, adjusted debt service ratios would increase in 2023, but “would remain significantly below the peaks seen ahead of the GFC.”

In response to questions at the FSR’s launch, Sir Jon Cunliffe, the Deputy Governor for Financial Stability, indicated that rates would have to rise significantly (200-500b) above current market expectations for the bank rate (3% at the time) for the share to reach previous highs (see “Financial inequality and debt vulnerability.”).

Fast-forward a mere 85 days and Huw Pill, the Bank’s chief economist, is suggesting that the Bank is likely to deliver a “significant monetary policy response” to protect sterling and fight rising inflation. Some financial market participants are arguing already that interest rates could reach 5.5% to 6% in 2023. In response, some UK mortgage lenders are pulling mortgage deals, citing the lack of certainty on how far interest rates may have to rise.

More importantly, if the latest market forecasts and the Bank’s earlier debt vulnerability forecasts turn out to be correct, rates will reach the levels at which the share of households with high, adjusted debt service ratios – those who are typically likely to struggle with debt repayments – could return to pre-GFC highs in 2023.

Please note that these summary comments are abstracts from more detailed analysis that is available separately.

“1Q22 Global debt dynamics – part 1”

Three key risks to popular narratives

The key chart

**1Q22 Public and private sector debt ratios (%GDP) by country** (Source: BIS; CMMP)

The key message

With global debt levels at a new, record high of $230 trillion and questions regarding debt sustainability dominating headlines, there are three key risks associated with popular investment narratives. The first is to treat the level of debt and the level of indebtedness synonymously. The second is to ignore the key structural shifts in global debt that have taken place since the GFC. The third is to dismiss the considerable differences that exist between the breakdown and level of indebtedness at the country level. The final risk is compounded by the fact that conventional macroeconomics typically ignores private sector debt while seeing public debt as a problem.

Debt versus indebtedness

While the level of total debt is at a new high, the level of indebtedness (261% GDP) is 30ppt below its 4Q20 peak (291% GDP). Similarly at the country level, the US and China collectively account for just over half of outstanding global debt but neither rank among the top-ten most indebted global economies. In contrast, Japan and France both rank among the top-five global economies in terms of their share of total debt and their level of indebtedness – yet, how often is France included in debates over debt sustainability?

Structural shifts

The first important structural shift in the post GFC period is the one away from relatively high-risk household (HH) debt towards lower-risk government debt driven largely by US and UK debt dynamics. The second is the “apparent” shift towards EM debt. In reality, this is a China-debt story rather than an EM debt story, however. EM ex-China’s share of global debt is largely unchanged since the GFC.

Country-level differences

Finally, considerable differences exist between the breakdown and levels of global debt ratios at the country level. Six of the 43 BIS reporting nations have above average private and public sector debt ratios – Japan, Singapore, France, Canada, Belgium and Portugal. A further 14 reporting nations have above average private sector debt ratios but below average public sector debt ratios – Hong Kong, Luxembourg, Sweden, Switzerland, the Netherlands, Denmark, Norway, South Korea, China, Ireland, Australian, Finland, Thailand, and New Zealand.

The key point here is that conventional macroeconomics typically ignores private debt while seeing public sector debt as a problem.

Note in this context, the emphasis that is typically placed on debt sustainability in the US, UK, and Italy despite the fact that these three nations are among the six reporting nations that exhibit above average levels of public debt but below average levels of private sector debt.

As noted previously, the US, Italy and Germany are also the only three advanced economies that have both household and corporate debt ratios below the levels that the BIS consider detrimental to future growth. A topic that I will return to in subsequent posts on private sector debt dynamics.

1Q22 Global debt dynamics – the charts that matter

Debt versus indebtedness

**Trends in total debt (USD billions, LHS) and debt ratios (%GDP, RHS) since 1Q08**
(Source: BIS; CMMP)

The outstanding stock of global debt hit a new, record high of $230 trillion at the end of 1Q22, according the latest BIS statistics (see chart above). The level of global indebtedness, expressed as the level of debt to GDP, has fallen from its 4Q20 peak of 291% GDP to 261% GDP, however.

Note that the level of debt and the level of indebtedness are not synonymous.

**Top-ten ranking of BIS reporting nations by total debt (USD billions, LHS) and**
**cumulative market share (%, RHS) as at end 1Q22** (Source: BIS; CMMP)

The US and China collectively account for over half of global debt but neither economy ranks among the top-ten most indebted global economies. At the end of 1Q22, the US and China accounted for 28% and 23% of the outstanding stock of global debt respectively (see chart above). In terms of indebtedness, the US and China rank only #16 and #13 globally, however (see chart below).

In contrast, Japan and France both rank among the top-five global economies in terms of their share of total debt (see chart above) and their level of indebtedness (see chart below) – yet, how often is France included in debates over debt sustainability?

**Top-ten ranking of BIS reporting countries by total debt ratio (% GDP)** (Source: BIS; CMMP)

Structural shifts

The first important structural shift in the post GFC period is the one away from relatively high-risk HH debt towards lower-risk government debt driven largely by US and UK debt dynamics. At the end of 1Q08, corporate (NFC), HH and government debt accounted for 38.7%, 31.5% and 29.9% of total debt respectively. At the end of 1Q21, these respective market shares were 38.7%, 24.9% and 36.5%. In other words, while the share of NFC corporate data remains unchanged there has been a clear shift away from HH to government debt.

As highlighted in “Challenging flawed narratives” earlier this month, the structure of US debt is now the mirror image of its pre—GFC structure. This follows the shift away from HH debt towards government debt and the passive deleveraging of the US HH sector (see charts below repeated from previous post).

**Shares of outstanding US non-financial debt by sector** (Source: FED; CMMP)

**Trends in US HH debt ($ tr) and HH debt ratio (% GDP)** (Source: FED; CMMP)

The second is the “apparent” shift towards EM debt. At the end of 1Q08, advanced economies and emerging markets accounted for 84% and 16% of outstanding global debt respectively. At the end of 1Q22, these respective shares had changed to 64% and 36% (see graph below).

**Trends in advanced and emerging markets shares of total debt (% total)** (Source: BIS; CMMP)

In reality, this is a China-debt story rather than an EM debt story, however. EM ex-China’s share of global debt is largely unchanged since the GFC. In contrast, China’s share of total global debt has increased from 5% at the end of 1Q08 to 23% at the end of 1Q21 (see chart below and “Global debt dynamics – V“)

**Trends in China and EM ex-China market shares of total debt (% total)** (Source: BIS; CMMP)

Country-level differences

Finally, considerable differences exist between the breakdown and levels of global debt ratios at the country level (see chart below). Six of the 43 BIS reporting nations have above average private and public sector debt ratios – Japan, Singapore, France, Canada, Belgium and Portugal (the top RH quadrant). A further 14 reporting nations have above average private sector debt ratios but below average public sector debt ratios – Hong Kong, Luxembourg, Sweden, Switzerland, the Netherlands, Denmark, Norway, South Korea, China, Ireland, Australian, Finland, Thailand, and New Zealand (the top LH quadrant).

The key point here is that conventional macroeconomics typically ignores private debt while seeing public sector debt as a problem.

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