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.
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).
Trends and forecasts for UK sector financial balances (% GDP) (Source: OBR; CMMP)
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.
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”).
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 (if their forecasts are correct, see below).
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.
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)
Previous OBR forecasts have assumed dramatic role reversals in the position of the UK government vis-à-vis the HH sector combined with sustained and significant current account deficits (see chart above).
This is an unattractive and unsustainable scenario but one that reflects the persistent flaw in conventional macro thinking that typically ignores the risks associated with private debt while seeing public debt as a problem rather than a solution.
The risk remains that “more-of-the same” forecasts will be interpreted as reverse engineering rather than reassurance for domestic and international investors and financial markets.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
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.
Inflation and falling real incomes affecting patterns more than levels of spending
The key chart
Credit and debit card payments in relation to pre-pandemic levels (Source: ONS; CMMP)
The key message
The message from the UK money sector is still one of resilient consumer spending, despite rising inflation and falling real incomes. Monthly spending on credit and debit cards in June 2022 was 1% above pre-pandemic levels and 6ppt above the level of monthly spending a year earlier.
UK households (HH) are increasing spending the most on getting to work and on staples. Spending on these categories was 32% and 13% above pre-pandemic levels in June 2022. Social spending was 1% above pre-pandemic levels, but spending on delayable goods such as clothing and furniture was still 16% below pre-pandemic levels.
Over the past 12 months, social spending and work-related spending have increased the most. Social spending has increases 18ppt from 83% pre-pandemic levels to 101% of pre-pandemic levels. Work related spending has increased 20ppt from 112% pre-pandemic levels to 132% pre-pandemic levels.
Delayable spending is the only spending category that (1) has fallen over the past twelve months and (2) remains below pre-pandemic levels. Delayable spending has fallen from 89% pre-pandemic levels in June 2021 to 84% pre-pandemic levels in June 2022. This matters because delayable spending is our preferred indictor regarding the extent to which excess savings are returning to the economy in a sustained fashion.
In short, the impact of rising inflation and falling real incomes is evident more on spending patterns than on the overall level of spending. UK HHs are increasing spending more on getting to work and on staples, unsurprisingly, and less on items such as clothing and furniture. Daily spending data through to 21 July 2022 is consistent with these monthly trends.
Please note that the summary comments and chart above are extracts from more detailed analysis that is available separately.
Are the UK and EA money sectors still sending consistent messages?
The key chart
Trends in UK and EA broad money (Source: BOE; ECB, CMMP)
The key message
The messages from the UK and euro area (EA) money sectors were remarkably consistent during the COVID-19 pandemic. Are they still sending consistent messages now?
Growth in broad money rose sharply in both regions during the pandemic, peaking in 1Q21. Growth in narrow money (M1), and overnight deposits with banks within this, was the main driver of broad money growth. UK and EA households (HHs) were increasing savings and delaying consumption – deflationary rather than inflationary forces. Note, in this context, that growth in private sector credit (key assets of banks) did not match the growth in broad money (key ST liabilities of banks). Indeed the gap between money growth and lending growth reached historically high levels in 1Q21. These were atypical money and credit cycles.
Broad money growth has slowed down to pre-pandemic levels now. UK and EA HHs are no longer hoarding cash. The demand for consumer credit has recovered with the largest quarterly flows since the recovery began in 2Q21. Consumer credit demand has returned to pre-pandemic levels in the UK but has still to recover fully in the EA. Growth rates in money supply and private sector credit have also re-aligned as money and credit cycles have re-synched with each other. In the EA, lending growth exceeded money supply growth in June 2022 for the first time since October 2011. The contribution of productive COCO-based lending has also increased in both regions. In the EA, for example, NFC lending grew faster than mortgages in June 2022.
In short, the key signals that I have been following consistently since early 2021 are all sending broadly positive messages for the economic outlook in both the UK and EA. The money sectors are still sending consistent messages, albeit with slightly different areas of emphasis.
The UK is more geared towards a recovery in consumer credit and has benefited from a stronger recovery here. Overall credit growth is slowing in the UK, however. The EA has seen a more promising recovery in lending to NFC and credit growth is still accelerating (in nominal terms).
As highlighted in the previous two posts, rising inflation has overshadowed all of these positive developments in the EA and the UK, however. Credit growth is negative in real terms in both regions, and leading, coincident and lagging monetary indicators are slowing sharply and in a coordinated fashion.
The synchronisation in the messages from the UK and EA money sectors extends to both the good and the bad news. Plenty for optimists and pessimists to debate here…
Still in-synch?
The messages from the UK and euro area (EA) money sectors were remarkably consistent during the COVID-19 pandemic. Are they still sending consistent messages now?
The impact of the COVID-19 pandemic
The impact of COVID-19 on UK and EA broad money growth (Source: BoE; ECB; CMMP)
Growth in broad money rose sharply in both regions to peak in 1Q21 (see chart above). In the UK, the YoY growth rate in M4ex rose from 7.5% in March 2020 to a peak of 15.4% in February 2021. In the EA, the growth rate in M3 rose from 7.5% in March 2020 to a peak of 12.5% one month earlier in January 12.5%.
Narrow money as %age of broad money in the UK and EA (Source: BoE; ECB; CMMP)
Growth in narrow money (M1), and overnight deposits with banks within this, was the main driver of broad money growth. M1 currently accounts for 69% of UK M3 and 73% of EA M3, up from 48% and 51% respectively a decade earlier. This means that UK and EA households (HHs) were increasing savings and delaying consumption during the pandemic – deflationary rather than inflationary forces.
Put simply, money sitting idly in bank deposits contributes to neither growth nor inflation.
The gap between UK and EA lending and money supply growth (Source: BoE; ECB; CMMP)
Note that the growth in broad money (bank’s ST liabilities) was not matched by growth in private sector credit (banks’ assets). Indeed the gap between growth in money and growth in lending reached historic highs in 1Q21. In short, the money and credit cycles had moved out-of-synch with each other, and to a record extent.
The recovery from COVID-19
Trends in UK and EA broad money (Source: BOE; ECB, CMMP)
Broad money growth has slowed down to pre-pandemic levels now (see chart above). In June 2022, growth in M4ex had slowed to 4.4% in the UK and growth in M3 had slowed to 5.7% in the EA. These represent the slowest rates of growth since January 2020 and February 2020 respectively.
Monthly HH money flows as a multiple of pre-pandemic average flows (Source: BoE; ECB; CMMP)
HHs are no longer hoarding cash. In the UK, monthly HH money flows fell to £1.5bn in June 2022, 0.3x the average pre-pandemic flow of £4.7bn. In the EA, monthly HH deposit flows fell to €8.5bn, again this is 0.3x the average pre-pandemic flow of €33bn (see chart above).
The demand for consumer credit has recovered with the largest quarterly flows since the recovery began in 2Q21. At the peak of the crisis in 2Q20, UK and EA HHs repaid £13.2bn and €12.9bn in consumer credit respectively. More recently, we have seen five consecutive quarters of positive consumer credit flows (see chart above).
Consumer credit demand has returned to pre-pandemic levels in the UK but has still to recover fully in the EA. In the 2Q22, UK consumer credit flows recovered to £4.2bn, above the pre-pandemic average of £3.6bn. EA consumer credit flows also recovered to €7.5bn, but they remain below the pre-pandemic average of €10.8bn.
Annual growth rates in UK and EA consumer credit (Source: BoE; ECB; CMMP)
Annual growth rates in consumer credit have also recovered to post-pandemic highs, to 6.5% in the UK and 3.3% in the EA in June 2022. Note the relative gearing of the UK here (see chart above). Consumer credit growth slowed faster and recovered stronger in the UK than in the EA.
Trends in the gap between UK and EA lending and money supply growth (Source: BoE; ECB; CMMP)
Growth rates in money supply and private sector credit have also re-aligned as money and credit cycles have re-synched with each other (see chart above). In the EA, lending growth exceeded money supply growth in June 2022 for the first time since October 2011. In the UK, lending growth still lagged money supply growth by 2.1ppt in June 2022, but this is much narrower than the peak gap of 11.5ppt seen in February 2021.
Trends in UK and EA bank lending by type (Source: BoE; ECB; CMMP)
The contribution of productive COCO-based lending has increased in both regions. In the EA, NFC lending grew faster (5.9%) than mortgages (5.3%) in June 2022. Less productive, mortgage lending remains resilient in the EA, but its growth is slowing in the UK (see chart above).
Conclusion
In short, the key signals that I have been following consistently since early 2021 are all sending broadly positive messages for the economic outlook in both the UK and EA. The UK has benefited from a stronger recovery in consumer credit. The EA has seen a more promising recovery in lending to NFC.
As highlighted in the previous two posts, rising inflation has overshadowed all of these positive developments, however (see “Accounting for inflation” and “Accounting for inflation – part 2”). Credit growth is negative in real terms in both the UK and EA, and leading, coincident and lagging monetary indicators are slowing sharply and in a coordinated fashion.
The synchronisation in the messages from the UK and EA money sectors extends to both the good and the bad news. Plenty for optimists and pessimists to debate here…
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
The BoE introduces an improved measure of affordability
The key chart
Share of outstanding mortgages and consumer credit by income decile (Source: BoE; CMMP)
The key message
Rising financial inequality means that lower-income HHs have less flexibility to adjust their spending in response to rising prices and are less likely to have a cushion of savings to protect them. But what does this mean for debt vulnerability in the UK, given that lower-income HHs also hold a relatively small share of outstanding mortgages and consumer credit?
In its latest “Financial Stability Review” (5 July 2022), the Bank of England introduced a new measure of HH debt affordability that takes account of these factors to deliver an improved assessment of HH vulnerability to rising prices and higher interest rates. The key points are:
The share of HHs with high, adjusted debt service ratios (DSRs) i.e. those who are typically more likely to struggle with repayments, is currently in-line with historic averages and well below pre-GFC peaks
The BoE believes that this share is unlikely to rise substantially in 2022. Further fiscal measures will cushion serviceability this year and the shift towards fixed mortgages (80% outstanding stock) delays the pass through effect of higher rates
Looking forward, the BoE expects this share to increase above its historic average in 2023, but to remain “significantly below the peaks seen ahead of the GFC.”
[In response to questions, Sir Jon Cunliffe, the Deputy Governor for Financial Stability, indicated that rates would have to rise significantly (200-500bp) above current market expectations for the bank rate (3.0%) for the share to reach previous highs.]
The obvious risks to this positive assessment, acknowledged by the BOE, include weaker growth, higher unemployment, persistent inflation, higher rates etc.
In the context of the recent deterioration in the net lending position of the HH sector, the risk that HHs may increasing their borrowing in order to fund rising living costs also remains important.
Financial inequality and debt vulnerability
What is the impact of financial inequality on household (HH) debt vulnerability?
Financial inequality means that lower-income HHs have less flexibility to adjust their spending in response to rising prices and are less likely to have a cushion of savings to protect them.
Share of income spent on taxes and essentials by gross income decile (Source: BoE; CMMP)
The share of income spent on essentials and taxes varies considerably across the UK income distribution (see chart above). HHs in the lowest income decile, for example, spend 94% of their gross income on taxes and essentials. In contrast, HHs in the highest income decile spend only 47% of their gross income on taxes and essentials. This means that lower-income HHs have much less freedom to change their behaviour in response to rising inflation.
HH savings ratio (%) broken down by gross income decile (Source: BoE; CMMP)
The savings ratio of lower-income HHs is also much lower than the savings ratio of higher-income HHs (see chart above). HHs in the bottom three income deciles save less than 6% of their gross income. This contrasts with HHs in the top two income deciles who save more than 30% of their gross income.
Obviously, this means that lower-income HHs are much less likely to have a savings cushion than can protect against rising prices. ( Note also that the COVID-19 pandemic led to a further widening of the savings disparity in the UK, as noted in previous posts.)
Share of outstanding mortgages and consumer credit by income decile (Source: BoE; CMMP)
That said, lower income HHs are also likely to hold a smaller share of both outstanding mortgages and consumer credit (see chart above).
Share of outstanding mortgages by income decile (Source: BoE; CMMP)
The bottom three income deciles account for 1.6%, 1.2% and 2.3% of total outstanding mortgages respectively, a cumulative market share of just over 5% (see chart above). The top income decile accounts for 33% of total mortgages alone and the top three income deciles together account for more than two-thirds of total mortgages.
The breakdown of consumer credit follows a similar, if less extreme, pattern. The bottom three income deciles account for 1.5%, 3.0% and 4.0% respectively, a cumulative market share of just over 8% (see chart below). The top income decile accounts for 20% of total consumer credit alone and the top three income deciles accounts for more than half of total consumer credit.
Share of outstanding consumer credit by income decile (Source: BoE; CMMP)
In its latest “Financial Stability Review”, the Bank of England introduces a new measure of HH debt affordability that takes account of these factors to deliver an improved assessment of the HH vulnerability to rising prices and higher interest rates.
The BoE claims that, “the share of HHs with high cost of living adjusted DSRs on either their mortgage or consumer credit has remained significantly below the pre-GFC peaks over the past few years.”
Share of HHs with high adjusted DSR on mortgage debt (Source: BoE; CMMP)
In the case of mortgages, the BoE estimates that 1.7% of HHs had a high, adjusted DSR at the end of 1Q22, up from 1.4% in 1Q20. This is close to the historic average but below the pre-GFC peak of 2.8% (see chart above). The BoE is expecting this share to remain at around the current level for the rest of 2022. This assumes that government support measures will relieve the pressure of rising living costs and also reflects the fact that 80% of outstanding mortgages are fixed rate now versus 55% five years ago.
Share of HHs with high adjusted DSR on consumer credit (Source: BoE; CMMP)
The story for consumer credit is much the same. The share of high, adjusted DSRs for consumer credit was 6.4% in 1Q22, up from 5.5% in 1Q20. This is also well below the pre-GFC peak of 9.5%. Again, the BOE is not expecting a major change here during the rest of 2022.
Looking slightly further ahead, the BoE believes that the shares of HHs with a high, adjusted DSR for both mortgages and consumer credit will increase in 2023, but “would remain significantly below the peaks seen ahead of the GFC.”
In response to questions, Sir Jon Cunliffe, the Deputy Governor for Financial Stability, indicated that rates would have to rise significantly (200-500bp) above current market expectations for the bank rate (3.0%) for the share to reach previous highs.
The obvious risks to this positive assessment, acknowledged by the BOE, include weaker growth, higher unemployment, persistent inflation, higher rates etc. In the context of the recent deterioration in the net lending position of the HH sector, the risk that HHs may increasing their borrowing in order to fund rising living costs also remains important.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Short-term comfort but more serious medium-term concerns
The key chart
UK net lending (+) / net borrowing (-) by sector from the capital account as % age of GDP (Source: ONS; CMMP)
The key message
Two official UK data points released last week – the 1Q22 household (HHs) savings ratio and May 2022’s consumer credit growth – provide short-term comfort but may hide more serious medium-term concerns for the UK economic outlook.
The positive news: HHs have room to adjust to falling real incomes by running down savings and increasing borrowings further. The adjustment process here remains at an early stage (see “Don’t be surprised”).
The negative news: while the net lending position of the HH sector widened slightly in 1Q21 (0.9% GDP), the UK private sector, in aggregate, moved into a net borrowing position (-1.4% GDP). At the same time, the public sector increased its net borrowing position further (-6.7% GDP).
So what? The irony of post-Brexit Britain, is that the economy is currently more dependent than ever on the net lending of the RoW. The challenges of the pre-Covid period have returned already – twin domestic deficits counterbalanced by significant (and persistent?) current account deficits.
These trends are not unexpected but that does not mean that they are either welcome or sustainable.
Don’t be surprised – part 2
Two official UK data points released last week – the 1Q22 HHs savings ratio and May 2022’s consumer credit growth – provide short-term comfort but medium-term concerns for the UK economic outlook.
Real HH disposable income growth (% QoQ) (Source: ONS; CMMP)
The context here is that real HH disposable income has fallen for four consecutive quarters (see chart above). Official forecasts suggest that this will continue for the rest of 2022 and in 2023.
In response, the same forecasts assume that HHs will reduce their savings ratio to a new low in 1Q23 by running down the excess savings built up during the pandemic (see chart below) and/or by increasing their borrowing. The positive news is that this process has hardly begun.
Trends in HH savings ratio (Source: ONS; OBR; CMMP)
The 1Q22 HH savings ratio was 6.8%, unchanged from the 4Q21 and above the OBR’s forecast of 6.3% (see chart above). Of course, this represents a large decline from the 2Q20 peak of 23.9%, but the 1Q22 ratio is only slightly below the 20-year average of 7.1%. (Note that the OBR expects the savings ratio to fall further to 2.8% in 1Q23.)
Monthly HH money flows as a multiple of pre-pandemic flows (Source: BoE; CMMP)
Furthermore, while monthly HH money flows have moderated sharply, they remain slightly above pre-pandemic levels during 2Q22 (see chart above). The result? Rather than declining, the stock of excess savings is increasingly slightly still (see chart below). CMMP analysis estimated that excess savings currently total £167bn.
CMMP estimates for build up of excess savings (Source: BoE; CMMP)
As an aside, the ONS also released the results of its modelling of the breakdown of the excess savings last week. The modelling suggests that so-called “forced savings” accounted for 75% of the increase in HH savings during the pandemic.
Estimates for excess savings broken down by type (Source: BoE; ONS; CMMP)
According to their calculation, this amounts to over £140bn, or around 10% of annual disposable income. This matters because forced savings are typically released relatively quickly to support economic activity (see “Forced versus precautionary”).
Monthly flows (£bn) and YoY growth rates in consumer credit (Source: BoE; CMMP)
Consumer credit grew 5.7% YoY in May 2022, unchanged versus the previous month (see chart above). This is the fastest rate of growth since February 2020 (5.8%) due in part to base effects. The monthly flow of consumer credit in May 2022 fell, however, from £2.0bn in February, £1.3bn in March, and £1.4bn in April 2022 to £0.8bn. May’s monthly flow is also below the pre-pandemic average of £1.1bn.
HH debt to income ratio (%) (Source: ONS; CMMP)
In other words, the demand for consumer credit has recovered – a welcome trend – but is not increasing at a rate that would suggest significant levels of distressed borrowing. HH debt as a percentage of disposable income, while elevated in absolute terms, has remained relatively stable since 2015 and below the peaks seen in the built up to the GFC.
So far, so good. Recent trends reflect a return to normality and suggest that HHs still have room to adjust to falling real incomes. It is not all good news, however. In “Don’t be surprised”, I highlighted the negative implications of forecast trends for both financial equality and economic sustainability. Last week’s data also shines further light on question of economic sustainability.
HH net lending/borrowing (% GDP) (Source: ONS; CMMP)
The net lending of the UK HH sector, i.e. the surplus resources that the HH sector makes available to other sectors, rose from 0.6% GDP in 4Q21 to 0.9% GDP in 1Q22 (see chart above). However, the UK private sector in aggregate shifted from a net lending position of 4.3% GDP in 4Q21 to a net borrowing position of 1.4% of GDP.
When combined with the net borrowing of the UK public sector of 6.7% in 1Q22, the UK’s net borrowing position with the rest of the world increased to 8.4% GDP (see chart below).
UK net lending (+) / net borrowing (-) by sector from the capital account as % age of GDP (Source: ONS; CMMP)
The irony of post-Brexit Britain, is that the 1Q22 net borrowing position with the rest of the world exceeds the previous highest borrowing seen in 4Q201 (7.0% GDP).
With both domestic sectors currently running net borrowing positions, the UK is more dependent than ever on net lending from the RoW (see chart above).
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
I posted a comment on LinkedIn last week about a so-called “basket-case” currency that is currently trading above its five-year average levels despite a host of negative economic, political and market-related factors.
The currency in question was the pound sterling and the graph illustrated the narrow version of the sterling exchange rate index (ERI) as calculated and published daily by the Bank of England (see key chart above).
The “tongue-in-cheek” post reflected an increasing frustration with excessive USD dollar-centricity in current financial and economic reporting.
USD – Sterling exchange rate (Source: BoE; CMMP)
Trends in bilateral exchange rates such as USD to sterling are important, of course, The US is the UK’s largest individual trading partner after all, and sterling is currently trading 7% below its five-year average versus the USD (see chart above). This is noteworthy in itself.
Sterling ERI weights (Source: BoE; CMMP)
That said, the UK economy is affected by (and reflected in) movements in sterling against many different currencies. As a bloc, the EU is the UK’s largest trading partner, for example. The region accounts for roughly double the US’s share of UK trade (see chart above). Sterling is currently trading 2% ABOVE is five-year average versus the EURO (see chart below), which helps to explain the trend in sterling’s ERI illustrated above (see key chart).
EURO – Sterling exchange rate (Source: BoE; CMMP)
This is not to deny that sterling is trending weaker, increasing the risk of imported inflation in the process. The sterling ERI has fallen 4% YTD. But, for a UK-audience at least, it is helpful to explore the extent to which reported trends in the bilateral exchange rate with the US are a reflection of USD strength as opposed to sterling weakness.
Perhaps the more important question, is why is sterling actually not trading much weaker than it is now?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is availability separately.
