“Note to Rishi”

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

The key chart

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

The key message

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

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

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

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

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

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

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

“Note to Rishi” – the charts that matter

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

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

Poised to disappoint – HH gross savings and savings ratio (Source: ONS; CMMP)
Private sector net lending position as % GDP (Source: ONS; CMMP)

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

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

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

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

According the latest ONS statistics, the net lending position of the UK private sector was still 6% GDP at the end of 2Q21, down from 10% in the previous quarter but still well above the LT (pre-COVID) average of just under 1% GDP. Both non-financial and financial corporations increased their net lending positions in 2Q21 to 1% of GDP respectively (see chart below).

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

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

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

Conclusion

As the UK emerges from the COVID pandemic, large sector imbalances remain but in very different ways to the pre-COVID period. The private sector continues to disinvest, HHs remain uncertain and credit demand (ex-mortgages) remains subdued. UK HHs have built up c£160bn of excess savings during the pandemic but history suggests that (1) they take time to respond to shocks and (2) that unanticipated increases in wealth tend to be saved rather than spent.

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

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