Historic and forecast trends in financial sector balances for the UK private sector, UK government and RoW expresses as a % GDP (Source: OBR; CMMP analysis)
Lesson #3
Given the importance of financial sector balances (lesson #2), it is a surprise that they only occupied two paragraphs and one chart in the OBR’s 217-page, “Economic and fiscal outlook” for the UK (November 2020). A cynic might wonder if this was because the one chart (reproduced above) countered much of the content of the other 216 pages. A more reasoned response might be that the power and application of financial sector balances remains under-appreciated even at these levels, which makes the framework more powerful for those who understand its implications.
In the case of the UK, for example, this approach highlights that official forecasts ask us to believe that UK households, corporates and overseas investors will behave highly unusually and with unprecedented degrees of dynamism in the post-pandemic period. Even then, the assumed result is simply a return to the unsustainable position pre-COVID where combined private and public sector deficits are offset by increasing RoW surpluses.
If we assume that November’s OBR forecasts are now a base case priced into UK assets, then lesson #3 points to downside risks to UK growth, upside risks to the level of borrowing, inflation staying below target and rates remaining lower for longer. More simply, lesson #3 also suggests that official forecasts can/often do fail common sense tests (see also lesson #4).
Increasing pressure on UK mortgage providers to digitalise
The key chart
Monthly flows (£bn) in UK lending to individuals throughout 2020 – mortgages have driven the recovery but this is still no time for providers to relax (Source: Bank of England, CMMP analysis)
The key message
The Bank of England’s latest Money and Credit release for October 2020 had three pieces of positive news for UK mortgage providers:
Mortgage demand remains relatively robust
Approvals for house purchases are at their highest levels since 2007
The effective interest rate on new mortgages has risen from its August low
This is no time for providers to relax, however. Current mortgage demand remains very subdued in relation to past cycles (despite the low cost of borrowing) and the pressure on net interest margins and revenue generation continues.
The strategic requirement to accelerate digitalisation across operations, sales, and finance and risk is growing.
“Lenders and brokers that use technology to differentiate and improve the customer experience will be the ones that ultimately come out ahead”
BSA, December 2020
Six charts that matter
Outstanding mortgages, YoY growth and monthly flows (£bn) throughout 2020 (Source: Bank of England; CMMP analysis)
In its October 2020, “Money and Credit” release, the Bank of England highlighted relatively robust UK mortgage demand. On a net basis, households borrowed £4.3bn in October, the third highest monthly borrowing total this year (see graph above). Outstanding mortgage balances grew 2.7% YoY in sharp contrast to the new record YoY decline in consumer credit (-5.6%YoY). Overall lending to individuals grew 1.6% YoY. As can be seen from the key chart above, mortgages accounted for £4.3bn out of a total (net) monthly flow of lending to individuals of £3.7bn. A rare bright spot.
Mortgage approvals for house purchase hit the highest level since September 2007 (Source: Bank of England; CMMP analysis)
Looking forward, mortgage approvals increased from 92,100 in September to 97,500 in October (see graph above). This is the highest level of approvals recorded since September 2007 and represents a 10x increase since May 2020’s low (9,400). High approval rates indicate that demand for mortgage borrowing should remain positive in the coming quarters.
Effective interest rate on new mortgages (Source: Bank of England; CMMP analysis)
The effective interest rate on new mortgages, which had been falling steadily since the end of 2018, increased to 1.78% in October. This compares with the recent low of 1.72% in August 2020 (see graph above). The effective rate has fallen 18bp YoY, however, and remains a negative drain on the rate on outstanding mortgages which has fallen 27bp YoY to 2.12% in October 2020.
Real growth rates in UK mortgage lending since October 2000 (Source: Bank of England; CMMP analysis)
Nonetheless, current mortgage demand remains relatively subdued in relation to past cycles despite the low cost of borrowing. In real terms, mortgage demand is growing at only 2.3% YoY, much slower than the double digit real growth rates seen before the GFC (see chart above). As described in previous posts, a key factor here is that, despite the deleveraging seen since 1Q10, the UK household debt to GDP ratio remains at 85%, the threshold level above which the BIS considers debt to be a drag on future growth (see chart below).
HH debt ratios remain elevated at the BIS threshold levels (Source: BIS; CMMP analysis)
Of on-going concern to mortgage providers, the effective rates on new and outstanding mortgages have fallen 10bp and 24bp YTD respectively. The gap between the rate in outstanding mortgages (which peaked at 55bp in February 2020) is still 34bp, indicating further downward pressure on net interest margins and revenue generation (see graph below).
The on-going challenge of delivering top-line growth (Source: Bank of England; CMMP analysis)
Conclusion
Despite the positive news noted above, this is not time for mortgage providers to relax. With subdued growth and further margin compression ahead, they need to embrace digitalisation to deliver effective market segmentation/client knowledge, alternative revenue sources, further efficiency gains and more effective liquidity and risk management.
As noted in a blog on the Building Societies’ Association website yesterday (2 December 2020), “Lenders and brokers that use technology to differentiate and improve the customer experience will be the ones that ultimately come out ahead.”
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately
Historic and forecast trends in financial sector balances for the UK private sector, UK government and RoW expressed as % GDP (Source: OBR; CMMP analysis)
The key message
The latest OBR forecasts for the UK economy and public finances support my argument that recent UK policy responses to the Covid-19 pandemic were timely, necessary and appropriate and that the UK government will maintain an increasingly interventionist role in the UK economy.
However, from my preferred “financial sector balances perspective” there are obvious risks to their forecasts for UK growth and for the level of government borrowing. First, they assume unprecedented levels of dynamism from both the UK household and corporate sectors and behavioural trends from these sectors and from the RoW that contrast sharply with those seen after the GFC. Second, while the OBR claims that “sectoral net lending positons return to more usual levels,” this does not make them sustainable.
In short, the latest forecasts point to a post-Covid, post-Brexit UK economy returning rapidly to persistent private and public sector deficits and an increasing reliance on the RoW as a net lender. Really…?
The charts that matter
The Office for Budget Responsibility (OBR) published its latest “Economic and Fiscal Outlook” yesterday (25 November 2020) in which it set out its forecasts for the UK economy and public finances to 1Q26. I have analysed these forecasts from the perspective of UK financial sector balances ie, the financial relationship between UK households (HHs), corporates (NFCs), government (GG) and the rest-of-the-world (RoW). As explained in a series of posts earlier this year, this approach builds on the key accounting identity pioneered by the late Wynne Godley that states that:
Domestic private balance + domestic government balance + foreign balance (must) = zero
Trends in UK financial sector balalances since 2000 (Source: OBS; CMMP analysis)
The OBR’s analysis supports my view that the UK government’s policy response to the Covid-19 pandemic was timely, necessary and appropriate. The OBR expects the cost of government support to total £280bn in 2020, pushing the deficit to £394bn (19% GDP), the highest level since 1944-45 and the debt ratio to 105% GDP, the highest level since 1959-60. Seen through the context of financial sector balances, the OBR concludes that, “The spike in government borrowing [the green line above] …has meant that household and corporate incomes have not fallen nearly as fast as their output or expenditure.” Note that the OBR expects the household financial surplus [the blue line above] to rise to a historically high level of over 11% GDP, and the corporate balance to move from a deficit to a historically high surplus of 2.5% GDP.
The support provided to households and businesses has prevented an even more dramatic fall in output and attenuated the likely longer-term adverse effects of the pandemic on the economy’s supply capacity. And the Government’s furlough scheme has prevented a larger rise in unemployment. Grants, loans, and tax holidays and reliefs to businesses have helped them to hold onto workers, keep up to date with their taxes, and avoid insolvencies.
OBR, November 2020
Historic and forecast trends for UK government financial sector balances – the bold and dotted lines represent March 2020 and November 2020 forecasts respectively. (Source: OBR; CMMP analysis)
The OBR forecasts also suggest that the UK government will continue to play an important part in economic activity. They predict that the government’s net borrowing peaks at -19% GDP in 1Q21, falls below -5% by 4Q22 and trends at around -4% GDP to 1Q26. These new forecasts imply higher levels of government borrowing than previously expected (note, there is no mention of balanced budgets or austerity). For government borrowing to fall in line with these expectations, HH and NFC spending have to rise more into line with income.
From a sector balances perspective, this is the point at which alarm bells begin to ring.
Historic and forecast trends for UK household financial sector balances – the bold and dotted lines represent March 2020 and November 2020 forecasts respectively. (Source: OBR; CMMP analysis)
Turning to the key HH sector first, the OBR forecasts assume that the financial surplus will peak at just under 14% GDP in 1Q21 and then fall rapidly to under 2% GDP by 3Q22 in line with the previous March 2020 forecasts. The HH savings rate is expected to fall sharply from 28% GDP in 2Q20 to “settle at around 7.5% over the medium term.” This is below the average savings rate of 9% recorded between 1986 and 2019. The OBR argues that forced savings have played a greater role in the rise of HH savings than previously thought. Their new forecasts assume that, “more of the boost to HH finances from forced saving during the lockdown is spent as the economy returns to normality.” On this basis, the OBR now expects private consumption to return to its pre-virus peak by the middle of 2022, much earlier than they forecast in July 2020.
Historic and forecast trends in UK household savings rate (Source: ONS; OBR, CMMP analysis)How the UK household sector adjusted in the post-GF C period – sector balances % GDP (Source: OBR; CMMP analysis)
To put these assumptions into a historic context, post the GFC, the HH sector’s financial surplus peaked at 6.1% GDP in 2Q10. It took 25 quarters for the surplus to fall below the 2% GDP level that the OBR now assumes HH will achieve in six quarters and sustain from 3Q22 onwards. Put simply, these forecasts ignore historical evidence from the UK and elsewhere that suggest that HH behaviour takes time to adjust from extreme shocks and implies obvious downside risks to the newly revised consumption and GDP forecasts, in my view.
Historic and forecast trends for UK corporate financial sector balances – the bold and dotted lines represent March 2020 and November 2020 forecasts respectively. (Source: OBR; CMMP analysis)
Turning now to the NFC sector, businesses reduced investment during the pandemic and moved into financial surplus in 3Q20. The OBR assumes that this surplus will peak at 3.2% GDP in 1Q21 and settle at a deficit of around 2.5% GDP out to 1Q26. In other words, the forecasts assume both (1) relatively high future investment levels and (2) a relatively dynamic adjustment. Again for context, after the GFC, the NFC sector ran net financial surpluses for 17 consecutive quarters between 1Q09 and 1Q13.
The complete picture – usual perhaps, but is this really sustainable? (Source: OBR; CMMP analysis)
Finally, the OBR observes that, “over the medium term, sectoral net lending positions return to more usual levels.” While they may be usual in the sense that they are not new, that is not the same as saying that they are sustainable. The latest forecasts not only assume dynamic adjustments by the HH and NFC sectors but they also assume a sustained period during which combined private and public sector deficits are offset by increasing Row surpluses.
Historic and forecast trends for RoW financial sector balances – the bold and dotted lines represent March 2020 and November 2020 forecasts respectively. (Source: OBR; CMMP analysis)
In other words, the current forecasts imply a return to persistent sector imbalances with the UK increasingly reliant on the RoW as a net lender (see Imbalances and dependencies).
Conclusion
If we assume that the OBR forecasts become the base case priced into UK assets, then financial sector balances point to downside risks to growth expectations, upside risks to the level of borrowing, inflation staying below target out to 1Q26 and rates remaining lower for longer. Plus ca change…
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
UK policy responses seen from a money sector perspective
The key chart
UK private sector and general government net lending/borrowing positions from the capital account expressed as a percentage of GDP (Source: ONS; CMMP analysis)
Large and persistent sector imbalances, an over-reliance on the RoW as a net lender and a household sector that was already poised to disappoint were challenging the economy even before Covid-19 hit. The immediate “Covid-19” response from the private sector was to increase its net lending position to a record 22% of GDP, almost 3x the equivalent response after the GFC. The HH savings ratio increased to a record 29% and HH consumption fell by the largest amount ever recorded (£81bn). In direct response to this negative shock, the UK government increased its net borrowing position to negative 23% of GDP – a timely and appropriate response.
Since then, the message from the UK money sector has remained one of high uncertainty and slowing consumption even before the latest round of restrictions began. Hence, the latest coordinated responses are also timely, necessary and appropriate. Looking ahead, current trends also suggest that: (1) the UK government will maintain an increasingly interventionist role; (2) the Bank of England will remain committed to keeping nominal and real rates “lower for longer”; and (3) investors hoping for a shift away from long duration fixed income and equity trades may require considerable patience.
Seven charts that matter
On 5 November 2020, the UK government and the Bank of England coordinated a larger-than-expected fiscal and monetary response to the latest Covid-19 wave and the second national lockdown. Rishi Sunak, the Chancellor of the Exchequer announced the extension of the furlough scheme until March 2021 and the Bank of England increases its bond-buying programme by £150bn. In the latest CMMP analysis, I consider this joint policy response in the context of (1) UK financial sector balances and (2) recent messages from the money sector.
The challenging starting point – trends in net lending/net borrowing expressed as a % GDP before the Covid-19 pandemic hit (Source: ONS; CMMP analysis)
Large and persistent sector imbalances, an over-reliance on the RoW as a net lender (see graph above) and a household sector that was already poised to disappoint were challenging the economy even before Covid-19 hit. Up until the 4Q19, the UK private and public sectors were running net borrowing positions at the same time that were offset by the RoW’s persistent net lending. The HH sector was funding consumption by dramatically reducing its savings rate and accumulation of net financial assets. With real growth in disposable income slowing and the savings rare close to historic lows, the risks to the UK economy already lay to the downside and at odds with previous government forecasts.
Trends in private sector net lending comparing the early-1990s recession and the GFC with 2020 (Source: ONS; CMMP analysis)
The immediate “Covid-19” response from the private sector was to increase its net lending position to a record 23% of GDP in 2Q20. In other words, the amount of money that the private sector had “left over” after all its spending and investment in 2Q20 was approximately 3x the equivalent amounts after the GFC and the recession of the early 1990s (expressed as a % of GDP).
Trends in HH gross savings and the HH savings ratio (Source: ONS; CMMP analysis)
The HH sector was the main driver here. HH gross savings rose to £104bn in 2Q20 and the savings rate increased to a record 29% compared with 10% in 1Q20 and 7% a year earlier. HH consumption fell by the largest amount ever recorded (£81bn), driven by large declines in spending on hotels, restaurants, travel, recreation and cultural services. The HH net lending position accounted for 20ppt of the total 23% private sector net lending in 2Q20, another record.
Trends in HH final consumption expenditure – the largest quarterly decline ever (Source: ONS; CMMP analysis)
In direct response to this negative shock, the UK government increased its net borrowing position to negative 23% of GDP – a timely and appropriate response. The main drivers here were the continuation of the Coronavirus Job Retention Scheme (CJRS), the introduction of the Coronavirus Self Employment Income Support Scheme (SEISS) and the Small Business Grant Fund.
A timely and appropriate response from the UK government (Spurce: ONS; CMMP analysis)
Since then, the message from the UK money sector has remained one of high uncertainty and slowing consumption even before the latest round of restrictions began. The latest Bank of England data showed that HH deposits increased by £7bn in September 2020. While this flow was below the £14bn, £16bn and £27bn monthly flows seen at the peak of uncertainty in March, April and June respectively it was still 1.5x the average 2019 monthly flows. Co-incidentally, September’s YoY growth rate in consumer credit was the weakest since records began (-4.6% YoY).
Monthly HH deposit flows since January 2019 (Source: Bank of England; CMMP analysis)
2020 trends in HH consumer credit – flows and growth rates. (Source: Bank of England; CMMP analysis)
Conclusion
In summary, the latest coordinated fiscal and policy responses are timely, necessary and appropriate. Looking ahead, current trends also suggest that: (1) the UK government will maintain an increasingly interventionist role; (2) the Bank of England will remain committed to keeping nominal and real rates “lower for longer”; and (3) investors hoping for a shift away from long duration fixed income and equity trades may require considerable patience.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Uncertainty reigns and consumption remains subdued
The key chart
The UK and EA money sectors sent a clear message this week (Source: Bank of England; ECB; CMMP analysis)
The key message
The UK and euro area (EA) money sectors sent a clear message to investors this week – don’t bet on the consumer.
Uncertainty reigns among European households. Monthly flows into deposits in the UK and EA remain 1.5-2.0x the average seen in 2019, despite negative real returns.
Yes, household lending has recovered from recent lows, driven by resilient (and rising) mortgage demand. Consumer credit demand, however, remains negative/weak. UK HHs repaid £0.6bn of consumer credit in September after additional borrowing in July (£1.1bn) and August (£0.3bn). The annual growth rate fell to -4.6%, a new low since the data series began in 1994. EA HHs borrowed €1bn for consumer credit in September, down from €3bn in August and €5bn in July, but the 0.1% YoY growth rate was the slowest since consumer credit recovered back in May 2015.
High uncertainty and slowing consumer spending were in place even before the introduction of the latest round of restrictions across Europe. No wonder that Madame Lagarde was so emphatic in warning investors to expect something more dramatic in December.
A simple message in six charts
Monthly UK household deposit flows since January 2019 (Source: Bank of England; CMMP analysis)Monthly EA household deposit flows since January 2019 (Source: ECB; CMMP analysis)YoY growth rates in UK and EA mortgage and consumer credit (Source: Bank of England; ECB; CMMP analysis)Monthly UK household credit flows since January 2020 (Source: Bank of England; CMMP analysis)Monthly EA household credit flows since January 2020 (Source: ECB; CMMP analysis)Trends in EA and UK inflation versus target since 2010 (Source: Bank of England; ECB; CMMP analysis)
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately
