Trends in cumulative HH and NFC financing flows (12-months, £bn) (Source: BoE; CMMP)
The key message
UK corporates and house buyers are reading the BoE’s script, even if consumers are not.
Cumulative 12-month financing flows to the household (HH) and corporate (NFC) sectors slowed to £8.3bn in November 2023, down from £65.2bn a year earlier (see key chart above).
Cumulative 12-month financing flows to the NFC sector have been consistently negative since January 2023
In November 2023, they were -£3.2bn compared with £3.2bn a year earlier i.e. corporates repaid debt throughout 2023
Note that the average cost of new NFC borrowing has risen by 495bp to 7.0% since the BoE began policy tightening (see chart below).
Trends in the average cost of new mortgages and NFC loans (%) (Source: BoE; CMMP)
Cumulative 12-month finance flows to the HH sector fell to £11.5bn in November, down from £61.3bn a year earlier
Lending for house purchases (mortgages) was net zero in November
The YoY growth rate for net mortgage lending was 0.3%, the lowest growth rate since the BoE’s monthly data series began back in March 1994
Note that the average cost of new mortgages has risen 384bp to 5.34% since the start of policy tightening (see chart above).
So what?
Financing flows to the UK private sector are falling sharply and reaching potential choke points for growth and much needed investment.
Beyond the headlines, there is a sharp contrast in terms of the dynamics of borrowing for consumption (resilient), investment (weak), and house purchases (slowing sharply).
While the message from the UK money sector remains relatively positive for on-going consumer demand, it is far more concerning with respect to investment and real estate.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Monthly consumer credit flows jumped to £2bn in November 2023
The key chart
Monthly flows (£bn) of UK consumer credit since November 2019 (Source: BoE; CMMP)
The key message
UK consumers are still not reading the BoE’s script – at least not fully.
Monthly flows of consumer credit rose to £2.0bn in November 2023 from £1.4bn in October 2023 and £1.5bn in September 2023 (see key chart above). The rise was largely attributable to a £0.5bn increase in borrowing on credit cards from £0.5bn in October 2023 to £1.0bn in November 2023.
The annual growth rate in the stock of consumer credit rose to 8.6% YoY, the highest rate since September 2018.
So what?
The BoE argues that, “higher interest rates make it more expensive for people to borrow money and encourages them to save.” The cost of borrowing has increased and households are saving more too. However, they also continue to borrow to fund consumption – in November the amount was 1.7x the average pre-pandemic flow.
In short, the BoE’s policy appears to resemble a three-legged stool that is missing an important leg…
Please note that the summary comments and chart above are abstracts of more detailed analysis that is available separately.
The OBR’s latest UK forecasts seen from a sectoral balances perspective
The key chart
Historic and forecast trends in sectoral balances for the UK private and public sectors and the RoW expressed as % GDP (Source: OBR; CMMP)
The key message
Viewed from a sectoral balances perspective, the Office of Budget Responsibility’s (OBR’s) latest “Economic and Fiscal Outlook” for the UK appears “too dull to be true”.
Too dull to be true?
Sectoral balances illustrate the financial relationship between different economic sectors. Between the UK private sector (households and corporates), the UK public sector and the rest-of-the-world (RoW), for example, in the key chart above.
The approach builds on the key accounting identity pioneered by the late Wynne Godley that states that:
Domestic private balance + domestic public balance + foreign balance (must) = zero
Pre-COVID, the UK was characterised by unsustainable macro imbalances. Both domestic sectors were running net borrowing (or deficit) positions at the same time. This left the UK increasingly reliant on net lending from the rest-of-the world – the ultimate irony for “post-Brexit Britain”.
The pandemic changed everything. The private sector shifted to unprecedented levels of net lending/surpluses. At its peak in 2Q20, private sector surpluses/disinvestment totalled almost 25% GDP. Fortunately, the UK government’s response was timely, rapid and appropriate with an offsetting deficit/investment of 25% GDP (see key chart above).
Recent (post-pandemic) OBR outlooks forecast a return to the pre-COVID world of unsustainable macro imbalances. The latest version is more optimistic, thanks in part to improved household dynamics.
In short, the OBR forecasts a balanced UK private sector – a net lending position for the household sector of 1.3% GDP in 1Q29 down from 2.6% GDP in 2Q23, but close to average levels, and a return to investment or net borrowing by UK corporates equivalent to -0.9% GDP. The OBR also expects net borrowing by the government to fall from -7.3% GDP to only -0.7% GDP over the same period.
The OBR concludes that, “Following large swings during the pandemic and energy crisis, sectoral balances are expected to return to historically more normal levels over the forecast period.”
A more cynical observer may conclude that the forecasts are simply too dull and/or too smooth to be true…
Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.
Contribution to total growth (ppt) plotted against share of total loans (%) (Source: BoE; CMMP)
The key message
Weakness in financing flows to UK SMEs (see, “How can UK SMEs invest in growth and job creation (II)?”) reflects broad-based, negative growth across all sectors or industry groups. While focusing (correctly) on addressing the challenge of inflation, policy-makers should remember that investment and business development matter too.
Every SME sector or industry group saw YoY declines in their outstanding stock of loans in August 2023. The largest decline was in recreation loans (-16% YoY), the smallest in real estate loans (-3% YoY). The total outstanding stock of SME loans fell by 8% YoY.
The trade, construction and real estate sectors were the largest contributors to this negative growth. They contributed -1.5ppt, -1.4ppt and -1.1ppt to the total -8% YoY decline respectively. These dynamics illustrate clearly the bias towards real estate – the smallest absolute decline but the third largest contribution to the total slowdown – and, to a lesser extent towards trade and construction.
Lending to these three sectors dominates SME lending in the UK. Collectively they account for just under half of the total SME loans, with the real estate sector accounting for 41% of total SME loans alone.
Real estate: monthly flows have been negative every month since February 2023. More importantly, the cumulative 12m flows that had turned positive in the 12m to January 2023, have been negative since then. Further confirmation of the changing fortunes in the wider real estate sector.
Wholesale and retail trade: monthly flows have been negative since October 2022. Cumulative 12m flows have been declining consistently since then to reach -£1.8bn in the 12 months to July and August 2023.
Construction: monthly flows have been persistently negative. Cumulative net flows remain negative at -£1.8bn in the 12 months to August 2023 but “less negative” than the -£2.1bn flows in November 2022, December 2022 and January 2023.
SMEs’ access to finance is systemically important to the UK economy. The broad-based weakness in lending across all sectors or industry groups is concerning and supports the wider hypothesis that SMEs are currently putting both investment and business development on hold. The influence of real estate also indicates that the bias towards less productive FIRE-based lending in the UK extends into the vital SME sector too.
“Looking behind the negative financing flows to UK SMEs?”
Trends in net lending flows to UK SMEs (Source: BoE; CMMP)
The persistent weakness in lending to the UK SME sector described in “How can UK SMEs invest fully in growth and job creation (II)?”, and illustrated in the chart above, reflects broad-based, negative growth across all sub-sectors or industry groups.
Annual growth rates in lending (% YoY) broken down by sector (Source: BoE; CMMP)
Every SME sector or industry group saw YoY declines in their outstanding stock of loans in August 2023 (see chart above). The largest decline was seen in the case of recreation loans (-16% YoY), the smallest in real estate loans (-3% YoY). The total outstanding stock of SME loans fell by 8% YoY.
The only exception here (and an important one!) is a sub-sector within real estate lending. The stock of lending for “buying, selling and renting of own or leased real estate”, which accounts for 31% of total SME lending, rose 1% YoY in August 2023.
Contribution to total growth (ppt) plotted against share of total loans (%) (Source: BoE; CMMP)
The trade, construction and real estate sectors were the largest contributors to this negative growth. They contributed -1.5ppt, -1.4ppt and -1.1ppt to the total -8% YoY decline respectively (see chart above). These dynamics illustrate clearly the bias towards the real estate sector in particular – the smallest absolute decline but the third largest contribution to the total slowdown.
Individual sector share (LHS) and cumulative share (RHS) by sector (Source: BoE; CMMP)
Lending to the real estate, trade and construction sectors dominates SME lending in the UK. Collectively these three sectors account for just under half of the total SME loans, with the real estate sector accounting for 41% of total loans alone. Once again, the UK’s skew towards less-productive FIRE-based lending is evident in the case of SME lending.
Trends in net lending flows to real estate (Source: BoE; CMMP)
Monthly flows to the real estate sector have been negative every month since February 2023 (see chart above). More importantly, the cumulative 12m flows that had turned positive in the 12m to January 2023, have been negative since then. Further confirmation of the changing fortunes in the wider real estate sector.
The negative growth contributions of the trade and construction sectors reflect both the size and lending dynamics of both sector. Both sectors account for 9% of total loans and both saw their outstanding stock decline by 15% YoY in August 2023. Only the much smaller recreational sector saw a larger YoY decline.
Trends in net lending flows to wholesale and retail trade (Source: BoE; CMMP)
Monthly flows to the wholesale and retail trade sectors have been negative since October 2022 (see chart above). Cumulative 12m flows have been declining consistently since then to reach -£1.8bn in the 12 months to July and August 2023.
Trends in net lending flows to construction (Source: BoE; CMMP)
Monthly flows to the construction sector have been negative every month over the period shown. Cumulative net flows remain negative at -£1.8bn in the 12 months to August 2023 but “less negative” than the -£2.1bn flows in November 2022, December 2022 and January 2023.
Conclusion
SMEs’ access to finance is systemically important to the UK economy. The broad-based weakness in lending across all sectors or industry groups is concerning and supports the hypothesis that SMEs are currently putting both investment and business development on hold. The influence of real estate also indicates that the bias towards less productive FIRE-based lending in the UK extends into the vital SME sector too.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
…when their cost of borrowing is rising so rapidly?
The key chart
Impact of policy tightening on the cost of borrowing for different UK sectors (Source: BoE; CMMP)
The key message
How can UK SMEs invest in growth and job creation when their cost of borrowing is rising so rapidly?
The average cost of new loans for SMEs has increased by 514bp from 2.51% when policy rate rises began in December 2021 to 7.65% in August 2023. This increase is greater than the respective increases in the average cost of borrowing for all NFCs (494bp to 6.97%), secured HH borrowing (324bp to 4.82%) and other HH borrowing (280bp to 9.07%). The spread between the average cost of borrowing for SMEs and the average cost for all NFCs has also widened slightly over the period (although only back in-line with pre-pandemic levels).
In response, some SMEs have been able to pass on the increased cost of borrowing to their customers. They are also more active in switching between funding providers and in considering alternative forms of finance.
Nonetheless, the rapid transmission of the Bank of England’s monetary policy to their cost of borrowing is another reason why SMEs are delaying plans for investment and other business development opportunities.
Returning to the central message of this series of three posts.
SMEs access to external finance is systemically important to the UK economy. They account for c.50% of private sector turnover and c.60% of employment. SMEs cannot invest fully in growth, job creation, innovation and equality, however, if and when:
their access to external capital is so constrained by LT structural factors;
flows of financing (both loans and overdrafts) are negative; and
their cost of borrowing is rising so rapidly
Government-backed institutions such as the British Business Bank and the Scottish National Investment Bank are actively working to make financial markets work better for SMEs and thereby drive sustainable growth and prosperity across the UK. Challenger banks and specialist lenders (e.g. Bibby Financial Services) are making a positive impact too in terms of both the volume of funding and the range of financing alternatives.
In short, the UK government, government-backed institutions and the private sector are combining successfully. That said, the challenges of repositioning the UK finance industry away from largely supporting capital gains (FIRE-based lending) to supporting production and income formation (COCO-based lending) instead, remain considerable. In the meantime, the wider UK economy remains the real loser here…
How can UK SMEs invest in growth and job creation (III)
This is the last of three short posts examining the challenges faced by UK SMEs in investing fully in growth and job creation. The previous posts focused on the structural and cyclical challenges relating to the volume of external financing. This post considers the cost of external financing, and the cost of bank lending specifically.
Trend in the average cost of borrowing for UK SMEs (Source: BoE; CMMP)
The average cost of new loans for SMEs has increased by 514bp from 2.51% when policy rate rises began in December 2021 to 7.65% in August 2023 (see chart above). This increase is greater than the respective increases in the average cost of borrowing for all NFCs (494bp to 6.97%), secured HH borrowing (324bp to 4.82%) and other HH borrowing (280bp to 9.07%), as shown in the graph below.
Changes in the cost of borrowing since BoE tightening began by sector (Source: BoE; CMMP)
The spread between the average cost of borrowing for SMEs and the average cost for all NFCs has also widened slightly from 48bp to 68bp over the period, but is below the recent peak of 119bp in November 2022. The current spread is also in-line with the average spread in the pre-pandemic period (see chart below).
Comparison of trends in cost of borrowing for SMEs and all NFCs (Source: BoE; CMMP)
How are SMEs responding?
According to a recent survey by Close Brothers Asset Finance, 60% of SMEs have been able to pass on the rising cost of financing to their customers. At the same time, 36% of those surveyed have switched funders in order to access more attractive deals and 52% have considered alternative forms of funding e.g. asset finance.
UK Finance research suggests that SMEs are utilising existing facilities while also drawing down on deposit holdings. That said, their survey also concludes that, “plans for investment or other business development opportunities appear to be on the back burner.” (UK Finance, October 2023).
Conclusion – the central message of this series
SMEs access to external finance is systemically important to the UK economy. They account for c.50% of private sector turnover and c.60% of employment. SMEs cannot invest fully in growth, job creation, innovation and equality, however, if and when:
their access to external capital is so constrained by LT structural factors;
flows of financing (both loans and overdrafts) are negative; and
their cost of borrowing is rising so rapidly
Government-backed institutions such as the British Business Bank and the Scottish National Investment Bank are actively working to make financial markets work better for SMEs and thereby drive sustainable growth and prosperity across the UK. Challenger banks and specialist lenders (e.g. Bibby Financial Services) are making a positive impact too in terms of both the volume of funding and the range of financing alternatives.
In short, the UK government, government-backed institutions and the private sector are combining successfully. That said, the challenges of repositioning the UK finance industry away from largely supporting capital gains (FIRE-based lending) to supporting production and income formation (COCO-based lending) instead, remain considerable. In the meantime, the wider UK economy remains the real loser here…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
…when monthly financing flows have been negative since March 2021
The key chart
Trends in net lending flows to UK SMEs (£bn) (Source: BoE; CMMP)
The key message
How can UK SMEs invest fully in growth and job creation when monthly financing flows have been negative since March 2021?
Most SMEs in the UK rely on bank loans and overdrafts as their main source of external financing. They use loans typically to finance investment and overdrafts for various cash-flow related purposes.
The previous post highlighted the structural challenges faced by SMEs in accessing external finance. This post considers the cyclical challenges they face with a focus on trends in financing flows to the SME sector.
Gross lending flows remain resilient in absolute terms – £63bn in the twelve months to August 2023 – but they are 40% below their peak level in the twelve months to February 2021 (£106bn) and 3% below the level recorded in the twelve months to December 2022 (£65bn).
The spike in gross lending during 2020 reflected the impact of various COVID-19 related schemes while the increase during 2022 reflected the positive impact of challenger banks and other specialist lenders who lent more to the sector than the UKs big five banks in 2021 and 2022.
Repayments of SME loans remain close to record levels, however, driven largely by the ending of various payment holidays. The result, as shown in the key chart above, is that net monthly lending flows to SMEs have been negative since March 2021 – a pessimistic message from the money sector in terms of SMEs’ future investment plans.
Demand for working capital products such as bank overdrafts, which had increased during 2022, has also slowed during 2023. According to the latest Bank of England data, monthly overdraft flows turned negative in the 12 months to June 2023 (-£0.2bn) and August 2023 (-£0.5bn).
In short, current cyclical trends compound the longer-term structural factors that inhibit SMEs ability to invest fully in growth and job creation in the UK. Net lending and overdraft flows are both negative. This is despite the positive impact of challenger banks and specialist lenders over the past two years.
The next post in this series will examine the extent to which these negative trends are exacerbated further but the transmission of the Bank of England’s monetary policy.
How can UK SMEs invest fully in growth and job creation (II)?
This is the second of three short posts examining the challenges faced by UK SMEs in investing fully in growth and job creation. It focuses on the cyclical challenge associated with negative bank financing flows. The previous post focused on the longer-term structural challenges at the micro and macro level. The subsequent post will examine the speed of monetary policy transmission to the cost of SME borrowing.
(Source: BoE; British Business Bank; CMMP)
Gross bank lending flows to SMEs slowed to £63bn in the twelve months to August 2023, down 3.4% from £65bn in 2022 and down 40% from their peak level of £106bn in the 12 months to February 2021 (see table above).
Note that the spike in lending in 2020 (see chart below) was largely driven by government guaranteed COVID-19 loans. These included the Coronavirus Business Interruption Loan Scheme (CBILS), Bounce Back Loan Scheme (BBLS) and Recovery Loan Scheme (RLS). Excluding these three schemes, gross lending was £48.1bn in 2020 and £49.7bn in 2021 (British Business Bank, 2023). Note also that there was also evidence of SMEs substituting loans for overdrafts as a source of working capital financing during the pandemic period.
Trends in gross lending flows to UK SMEs (£bn) (Source: BoE; CMMP)
The increase in gross lending in 2022 has been attributed to increased supply from challenger banks and specialist lending. Gross lending from these sources was £29.2bn in 2021 and £35.5bn in 2022, the highest annual level since records began in 2012 (British Business Bank, 2023). Challenger and specialist banks’ share of gross lending exceeded that of the big five UK banks in both 2021 and 2022. (SMEs recorded less success in obtaining all the financing they need from their finance providers and a greater willingness to use more than one provider.)
Trends in repayments by UK SMEs (£bn) (Source: BoE; CMMP)
Gross repayments of SME loans peaked in January 2023 at £74bn and have slowed to £72bn in the twelve months to August 2023 (see chart above). In calendar-year terms, the £73.8bn repayments in 2022 were the highest since records began in 2012. They were driven largely by the end of the one-year holiday on paying back the principal and interest on BBLS loans and on paying back interest on CBILS loans for those SMEs that had taken the last opportunity to draw them down.
Trends in net lending flows to UK SMEs (£bn) (Source: BoE; CMMP)
Net monthly flows reflect the balance between the gross lending flows and repayments described above. As can be seen in the chart above, net monthly bank lending flows to SMEs have been negative since March 2021 – a pessimistic message from the money sector in terms of SMEs future investment plans.
Trends in overdraft flows to UK SMEs (£bn) (Source: BoE; CMMP)
Demand for working capital products such as bank overdrafts, which had increased during 2022, has also slowed during 2023. According to the latest Bank of England data, they turned negative in the 12 months to June 2023 (-£0.2bn) and August 2023 (-£0.5bn).
Conclusion
In short, current cyclical trends compound the longer-term structural factors that inhibit SMEs ability to invest fully in growth and job creation in the UK. This is despite the positive impact of challenger banks and specialist lenders over the past two years.
The next post in this series will examine the extent to which these negative trends are exacerbated further but the transmission of the Bank of England’s monetary policy.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
…when access to external capital is so constrained?
The key chart
Trend in the outstanding stock of SME loans since 2013 (£bn) (Source: BoE; CMMP)
The key message
How can UK SMEs invest fully in growth and job creation when access to external financing remains so constrained?
SMEs play a vital role in supporting economic growth and job creation in the UK. They account for c.50% of private sector turnover and c.60% of employment.
SMEs’ access to finance is systemically important, therefore, to the UK economy.
SMEs enjoy access to a variety of funding options, at least in theory, and increased supply from challenger banks and specialist lenders, in practice. Nonetheless, access to external finance remains one of their biggest challenges.
Over the past decade, for example, the outstanding stock of loans to SMEs has grown by only 1.1% CAGR in nominal terms, even after the boost in bank lending associated with government guaranteed COVID-19 loans.
There are a number of structural factors at play here (analysis of additional cyclical factors will follow). At the micro level, these include low levels of financial literacy among SMEs, limited knowledge of the full range of funding options and the mismatch with banks’ lending criteria, risk appetite and the financial history of SMEs.
At the macro level, the challenge is more fundamental. UK finance is not geared to support production and income formation (so-called “COCO-based” lending). Only 22 pence in every pound lent in the UK is for this purpose, with lending to SMEs an even smaller sub-segment of this (c.7 pence). UK finance is geared instead towards supporting capital gains largely through higher prices for real assets (mortgages) and financial assets (so-called “FIRE-based” lending).
The aim of the British Business Bank and other specialist lenders (and brokers) is to make UK financial markets work better for SMEs and thereby drive sustainable growth and prosperity across the UK. The structural challenges here are large and enduring. The next two posts in this series, will examine shorter-term cyclical trends to see if their job is becoming easier or harder still.
How can UK SMEs invest fully in growth and job creation – Part I
This is the first of three short posts examining the challenges faced by UK SMEs in investing fully in growth and job creation. It focuses on the structural challenges involved in accessing finance.
The following posts will focus on the cyclical challenges relating to financing flows (Part II) and the cost of finance (Part III).
To fulfil their role in supporting growth and job creation, SMEs need access to external finance to (1) fuel growth, (2) fund working capital, and (3) invest in new assets/equipment. They enjoy access to a variety of funding options including:
Bank loans and overdrafts
Government grants and support programmes (e.g. COVID-19 loans)
Venture capital and angel investments
Leveraged loans
Crowdfunding
Peer-to-peer lending
Property/commercial mortgages
Asset finance and refinance
Commercial loans
Invoice financing
Asset-based lending
Most SMEs typically rely on the first of these options. According to a recent Bank of England study, bank overdrafts and credit cards are used primarily for various cash flow related purposes and short-term funding gaps, while bank loans and various forms of asset-based lending are used for business investment (e.g. capex expansion, R&D etc).
Trend in the outstanding stock of SME loans since 2019 (£bn) (Source: BoE; CMMP)
The outstanding stock of loans to UK SMEs was £188bn as of the end of August 2023, down 13% from its March 2021 high of £216bn (see chart above). More significantly perhaps, this stock has only grown by 1.1% CAGR over the past decade, even when the impact of government guaranteed COVID-loans is included (see key chart above). In the six years between August 2013 and August 2019, the stock of loans fell by -0.2% on a CAGR basis and less than half of SMEs made use of external finance. Unsurprisingly then, access to finance is seen as one of the biggest challenges facing SMEs along with rising costs.
Why is this the case?
At the micro level, levels of financial literacy among SMEs are relatively low. According to a recent Ipsos UK study for the British Business Bank, 70% of SMEs lack awareness of their available financing options and another survey suggested that 85% of them borrowed exclusively from banks. On the supply side, almost 60% of SMEs and their brokers agree that finding funding has become more challenging over the past five years. A 2023 Praetura study, highlighted the mismatched lending criteria, risk and financial history as the most likely reasons why an SME is turned down for funding from an institutional level.
M4L broken down by contribution of COCO-based and FIRE-based lending (£bn) (Source: BoE; CMMP)
At the macro level, the reason why access to financing is so challenging is more fundamental. The UK finance industry is not geared to support production and income formation – so called “COCO-based” lending. Only 22 pence in every pound lent in the UK is for this purpose, with lending to SMEs an even smaller sub-segment of this (c.7 pence in every pound lent). UK finance is geared instead towards so-called “FIRE-based” lending. Almost 80 pence in every pound lent supports capital gains largely through higher prices for real assets (mortgages) and financial assets (see chart above).
The aim of the British Business Bank and other specialist lenders (and brokers) is to make UK financial markets work better for SMEs and thereby drive sustainable growth and prosperity across the UK. The structural challenges here are large and enduring. The next two posts in this series, will examine shorter-term cyclical trends to see of their job is becoming easier or harder still.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Trends in average cost of borrowing for SMEs, PNFCs and HHs since December 2021 (Source: BoE; CMMP)
The key message
Who are the real losers in the BoE’s policy tightening race – UK SMEs or the wider UK economy?
The transmission of monetary policy to the cost of borrowing for SMEs has been rapid (+514bp) and faster than for average corporate borrowers (+494bp) and for households (+324bp). Monthly financing flows to the sector have also been negative since March 2021.
On the face of it, not good news for UK SMEs…
Looking behind the headlines, however, gross lending flows to the sector have been relatively stable so far this year (£4.9bn average YTD). They are slowing however on a cumulative 12-month and 3-month basis and, more importantly, they remain below the flows of monthly repayments.
In short, in the face of subdued demand and higher financing costs, SMEs are adopting prudent financing strategies. They are “utilising existing facilities and diverting some deposits to secure higher returns” (UK Finance, September 2023). Hence the subdued demand for new credit.
Why does this matter?
The key message from the money sector is that UK SMEs’ plans for future investment appear to be “on hold”. Given that they account for c.50% of private sector turnover in the UK and c.60% of employment, this suggest that the real loser here is the wider UK economy…
Who are the real losers in the BoE’s policy tightening race?
The transmission of monetary policy to the cost of borrowing for SMEs has been rapid and faster than for larger corporates and for households.
Trend in average cost of new SME borrowing (%) (Source: BoE; CMMP)
The average cost of new loans for SMEs has increased 514p from 2.51% when policy rate rises began in December 2021 to 7.65% in August 2023 (see chart above).
As shown in the key chart above, this increase is greater than the respective increases for average corporate borrowing (494bp), secured household borrowing (324bp) and other household borrowing (280bp).
Monthly net lending flows (£bn) (Source: BoE; CMMP)
Monthly financing flows to the SME sector have been negative since March 2021 (see chart above). Note that these trends reflect a balance between gross lending flows and repayments.
Looking behind the headlines, we discover that gross lending flows to UK SMEs have been relatively stable so far this year – £4.9bn average YTD (see chart above).
On a cumulative 12-month and 3-month basis they are slowing however, and they remain below monthly repayments (see chart below).
Monthly gross lending, repayments and net lending flows (£bn) (Source: BoE; CMMP)
In short, in the face of subdued demand and higher financing costs, SMEs are adopting prudent financing strategies. According to UK Finance analysis they are “utilising existing facilities and diverting some deposits to secure higher returns.”
Conclusion
The key message from the money sector is that UK SMEs’ plans for future investment appear to be “on hold”. Given that they account for c.50% of private sector turnover in the UK and c.60% of employment, this suggest that the real loser here is the wider UK economy…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Financing flows to the UK private sector are collapsing too
The key chart
Trends in cumulative financing flows to the UK private sector (12 months, £bn) (Source: BoE; CMMP)
The key message
The latest “Money and Credit – August 2023” data release from the Bank of England shows financing flows to the private sector collapsing in the UK – this story is not unique to the euro area (see “Choke Point?”).
Cumulative monthly financing flows to UK corporates and to households have fallen from £66bn in the 12 months to August 2022 to only £17bn in the twelve months to August 2023. If we include relatively volatile flows to non-intermediate financial companies, positive flows have become negative, net repayments of £42bn (see key chart above).
The average cost of borrowing for corporates has increased 494bp from 2.03% in December 2021 (when BoE rate increases began) to 6.97% in August 2023. In response, they have repaid loans in six of the past ten months, and cumulative 12-month financing flows have been negative for the past eight months. Behind the headlines, UK SMEs also face the extra “dual challenge” of lower lending volumes (negative YoY growth since August 2021) and even higher borrowing costs (7.65% average, up 514bp since December 2012).
The average costs of secured and other household borrowing have increased by 325bp (from 1.58% to 4.82%) and 280bp (from 6.27% to 9.07%) respectively over the same time-period. Households have repaid loans in two of the past five months and cumulative 12-month financing flows have declined from £64bn in the 12 months to August 2022 to £23bn in the twelve months to August 2023.
So what – why does this matter?
The BoE and the ECB lack playbooks for such aggressive periods of monetary tightening. Financing flows to the UK and EA private sectors are falling sharply and reaching a potential “choke point” for growth and much-needed investment. Central bankers may argue that this suggests that the transmission of monetary policy is working. Others might view such as rapid pace of adjustment as an indicator that the risks of policy errors and risks to future growth are rising very sharply…
Financing flows to the UK private sector are collapsing too
The latest “Money and Credit – August 2023” data release from the Bank of England shows financial flows to the private sector collapsing in the UK (see chart below).
The collapse in cumulative 12-month financial flows to the UK private sector (12 months to August, £bn) (Source: BoE; CMMP)
Cumulative monthly financing flows fell from £77bn in the 12 months to August 2022 to net repayments of £42bn in the twelve months to August 2023 (blue bars in chart above). This data includes volatile flows to non-intermediating financial companies. Excluding these, financing flows to corporates (PNFCs) and households (HHs) fell from £66bn to £17bn over the period (maroon bars in chart above).
Trend in the average cost of new loans to UK PNFCs (%) since August 2018 (Source: BoE; CMMP)
In response to the 494bp increase in the average cost of borrowing from 2.03% in December 2021 (when the BoE rate increases began, see chart above) to 6.97% in August 2023, PNFCs have repaid loans in six of the past ten months.
Despite two consecutive months of positive flows to PNFCs in July 2023 (£1.3bn) and August 2023 (£0.5bn), cumulative 12-month financing flows have been negative for the past eight months. In the 12 months to August 2023, PNFCs repaid £6.2bn in loans (see chart below).
UK PNFCs have repaid loans in six of the past ten months (Source: BoE; CMMP)
Note also that, behind the headlines, the average interest rate on new loans to SMEs has increased by 514bp from 2.51% in December 2021 to 7.65% in August 2023.
Trends in growth rates in corporate loans since August 2018 (% YoY) (Source: BoE; CMMP)
The annual YoY growth rate in lending to SMEs has been negative since August 2021 (see chart above). In short, SMEs face the dual challenge of lower lending volumes and higher borrowing costs.
Trend in the average cost of new loans to UK HHs (%) since August 2018 (Source: BoE; CMMP)
In response to a 324bp increase in the average cost of new secured HH lending (the largest segment of HH borrowing) and 280bp in the average cost of other HH lending (see chart above), HHs have repaid loans in two of the past five months. Despite a recovery in HH financing flows in July 2023 (£0.9bn) and August 2023 (£1.3bn), cumulative financing flows have fallen from £64bn in August 2022 to £23bn in August 2023 (see chart below).
Cumulative flows to UK HHs have fallen to £23bn in August 2023 (Source: BoE; CMMP)
Conclusion
The BoE and the ECB lack playbooks for such aggressive periods of monetary tightening. Financing flows to the UK and EA private sectors are falling sharply and reaching a potential “choke point” for growth and much-needed investment.
Central bankers may argue that this suggests that the transmission of monetary policy is working. Others might view such as rapid pace of adjustment as an indicator that the risks of policy errors and risks to future growth are rising very sharply…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Squeezing both sources of UK money creation simultaneously
The key chart
Forty year trends in UK debt “relative growth factors” (3Y CAGR in debt versus 3Y CAGR in nominal GDP) (Source: BIS; CMMP)
The key message
The two sources of UK money creation – government spending and bank lending – are being squeezed at the same time. This does not bode well for future growth prospects (or for the re-election prospects of the current government).
Turning both taps off at the same time
UK government and private sector debt are growing at a slower pace than nominal GDP, and at the same time.
According to the latest BIS data release, government debt has declined by -2.4% on a rolling 3-year CAGR basis to the end of 1Q23. Over the same period, nominal UK GDP has increased by 3.8%, resulting in a “relative growth factor” of -6.0ppt.
Household (HH) and corporate (NFC) debt have risen by 3.1% and 0.2% on the same basis, but again at a slower rate of growth than nominal GDP, resulting in relative growth factors of -0.6ppt and -3.5ppt respectively (see key chart above).
So what?
Some economists draw the analogy between debt to GDP ratios and the relative growth factors described above and the speed of a car and the rate of acceleration or deceleration respectively. In this context, the “UK car” is not only travelling slower, the rate of growth is also decelerating at the same time.
Why do economists often overlook (or underestimate) these trends?
For the simple season that traditional macro frameworks typically ignore private sector debt and its impact on aggregate demand.
When aggregate demand is viewed correctly as being equal to income (GDP) plus the change in debt, these dynamics become far more concerning, however – especially for an incumbent government seeking re-election.
Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.
