“Riding to the rescue”

The key chart

The key message

UK households (HHs) play a vital role in the UK economy and in the demand for credit. Looking forward, the key question is will the HH sector ride to the rescue or is it poised to disappoint again?

Official forecasts assume a strong recovery in HH consumption over the 2H21 as the economy starts to open. If all the additional savings accumulated during the pandemic were spent over the next four quarters, it would add c.6% to consumption in 2021 and 2020. Such a bullish scenario is unlikely for three reasons:

• HHs typically save most unanticipated sources of wealth rather than spend them
• The rise in savings is skewed towards high-income households who typically have lower marginal propensities to consume;
• History suggests that HHs (and NFCs) typically take time to re-adjust after periods of significant financial and/or economic shock.

That said, the scale of accumulated HH savings provides support for a more rapid re-adjustment than after the GFC (the central OBR forecasts is consistent with HHs on average spending 5% of the extra deposits) and suggests that the UK has a higher level of gearing to a recovery than the euro area (EA). Potentially good news for suppliers of consumer durables…

Riding to the rescue

HHs matter

UK households (HHs) play a vital role in the UK economy and in the demand for credit. HH consumption accounts for 65p in every pound of UK GDP and lending to HHs accounts for 66p in every pound of M4 Lending. HHs are important investors in financial and non-financial assets (mainly property), with balance sheets skewed towards financial assets. The sector is typically a net saver/net lender in the UK (and other developed economies). However, notable shifts in the HH net financial balances have occurred in the post-GFC period and during the COVID-19 pandemic. A key theme in the analysis below it that the unwinding of HH savings built up during the pandemic will play an important role in determining the scale, pace and sustainability of any economic recovery.

Disappoint or ride to the rescue?

Looking forward, the key question is will the HH sector ride to the rescue or is it poised to disappoint again? The sector was poised to disappoint at the start of 2020 with risks to official forecasts tilted clearly to the downside.

HH debt levels peaked at 96% GDP in 1Q10 and, after a period of “passive deleveraging”, stabilised at c.85% GDP from 2Q14 onwards (note that 85% GDP is the maximum threshold level above which the BIS assumes that debt becomes a constraint on future growth). Despite low debt servicing costs, HHs chose to fund consumption by slowing their rate of savings (and accumulation of net financial assets) rather than by increasing their debt levels. With real growth in disposable income slowing, however, and with the savings rates still close to historic lows, the risks to HH consumption and GDP growth were tilted clearly to the downside before COVID-19 hit.

Official forecasts assume a strong recovery in HH consumption over the 2H21 as the economy starts to open (see table above). After falling 11% in 2020, HH consumption is forecast to recover 2.9% in 2021, contributing 1.8ppt to GDP growth of 4.0% and then to grow 11.1% in 2022 contributing 7.0ppt to GDP growth of 7.3% (OBR, March 2021 forecasts).

What if?

If all the additional savings accumulated during the pandemic were spent over the next four quarters, it would add c6% to consumption in 2021 and 2020. In recent posts, I have noted the increase in HH deposits (“COVID-19 and the flow of financial funds in the UK”).

HHs increased their deposits by £100bn in the first three quarters of 2020 and by a further £53bn in the 4Q20 alone. The OBR expects the level of “additional deposits” to reach £180bn by the middle of 2021. In the unlikely scenario that all these additional deposits were spent over the next four quarter, the OBR estimates that it would add c6% to consumption in 2021 and 2020.

Not so fast…

Such a positive scenario is unlikely for three key reasons. First, HHs typically save most unanticipated sources of wealth rather than spend them. Traditional consumption theory suggests that rather than spending all of an unanticipated increment to their wealth immediately, HHs are instead more likely to save most of it to allow for higher consumption in the future. An autumn 2020 BoE survey supports this theory. Only 10% of HHs planned to spend the additional savings built up during the pandemic. In contrast, around 66% planned to retain them in their bank account. (Note, that the first of the CMM three key charts for 2021 measures monthly HH deposit flows in relation to past trends).

Second, the rise in savings is skewed towards high-income HHs. Another recent BoE survey notes that 42% of high-income HH were saving more and 16% saving less, compared to 23% of low-income HHs saving more and 24% saving less. This matters because high-income HHs typically have lower marginal propensities to consumer than low-income HHs. Empirical evidence suggests that annual spending typically rises by between 5-10% of unanticipated, incremental increases in wealth.

Third, history suggests that HHs (and NFCs) typically take time to re-adjust after periods of significant financial and/or economic shock. In the aftermath of the GFC, for example, the net savings of the HH sector peaked at 6.1% GDP in 2Q10. It took 26 quarters before net savings fell below 2% GDP (4Q16).

The COVID-19 pandemic was a greater financial, economic (and mental) shock than the GFC. In response, the HH sector’s net savings increased from 0.4% at the end of 2019 to 7.0% in 3Q20. OBR forecasts indicate that net savings increased to 8.7% at year-end and are expected to peak at 10.4% GDP in 1Q21 (4.3ppt higher than post-GFC). Their forecasts also assume a rapid re-adjustment by HHs as vaccination levels rise and the economy re-opens with HH net savings falling below 2% by 3Q22 (ie, in six quarters) and remaining below 0.5% out to 1Q26. In my view, risks to these assumptions lie to the downside ie, HH net savings will remain higher than forecast here as HHs maintain larger precautionary savings.

But, what if size does matter…

The scale of accumulated HH savings provides support, however, for a more rapid re-adjustment than after the GFC and suggest that the UK has a higher level of gearing to a recovery than the euro area (EA).

The central OBR forecasts is “consistent with HHs on average spending 5% of the extra deposits accumulated during the pandemic each year, but somewhat front loaded into 2H21 and 1H22.” In other words, the OBR forecasts suggest that c.25% of the total stock of £180bn built up during the pandemic will have been used for consumption by 1Q26. This seems a reasonable assumption, in my view.

Note also that the “messages from the money sector” indicate that the scale of additional deposit flows in the UK, in relation to past trends, is higher in the UK than in the EA. In December 2020, for example, the monthly flow of HH money (£20bn) was 4.5x the average monthly flow recorded in 2019. In the EA, the respective multiple was 1.8x.

Potential beneficiaries?

If correct, the rebound in HH consumption is potentially good news for suppliers of consumer durables. So-called “social consumption” will naturally benefit too, but there is only so much lost time that can be made up (you can only eat so many meals in one day!). It is reasonable to assume, therefore, that a large proportion of additional expenditure is directed towards durable goods whose consumption is more likely to have been delayed during lockdown (eg, car sales).

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