Tuesday, June 28, 2005
Dropping shopping
Posted by David Smith at 05:58 PM
Category: David Smith' s magazine articles

One of the constant refrains about Britain’s economy in recent years has been its over-reliance on the consumer and, in consequence, the unbalanced nature of growth. The figures speak for themselves.

Over the period 1997 to 2000 consumers accounted for 80 per cent of the rise in total economic activity. The share dropped slightly after that, but only because of the sharp rise in public spending. Growth in Britain has been on a record run – 51 quarters and counting – but “productive” growth, in the form of investment and exports, has been in short supply.

Lately, however, there are signs that not all is well for Britain’s once-unstoppable consumers. Since before Christmas retailers have been grumbling about the reluctance of shoppers to spend, irrespective of the inducements that are put their way.

For once the retailers, who are given to moaning, have a point. Consumer spending did indeed slow sharply at the end of last year; in the fourth quarter of 2004 it rose by just 0.7 per cent at an annualised rate, compared with nearly 5 per cent at the beginning of the year.

Regular reports from Britain’s high streets and shopping malls so far this year suggest the malaise has continued. The British Retail Consortium said year-on-year performance in April was the worst since 1992, when the economy was just emerging from the last recession. Several retailers have posted profits warnings or grim trading statements. Shoppers, it seems, have gone on strike.

It is not obvious why this should be happening, as John Butler, UK economist at HSBC, points out. “Consumer spending has been slowing in a background in which employment and financial wealth has been rising,” he says. “And if the consumer is tired, what parts of the economy will take up the growth baton?”

The slowdown in spending, as Butler points out, is intimately related to what has been happening to the housing market. Last year the Bank of England created controversy by suggesting that even if house prices fell, consumers would not respond by cutting their outgoings. House prices have not fallen, at least nationally, but the market has stagnated and that has had a significant impact, it seems, on consumers.

The direct effects of a loss of momentum in the housing market are well known. When people aren’t moving they don’t spend as much on carpets, curtains, furniture and redecoration. And, while few tears will be shed, they also deprive a whole range of service providers, from estate agents and solicitors through to removal firms, of business.

The indirect effects are, however, arguably greater. Mortgage equity withdrawal, the act of taking out housing wealth to use for other spending, happens most when property transactions are booming. When lending slows sharply, as it has, there is far less of it. Equity withdrawal dropped from £16 billion in the final quarter of 2003 to £6 billion a year later. There are probably more falls to come. The upshot is that you did not need a house-price crash to produce a spending slowdown.

Tied to that is another factor. The rise in debt has been going on for so long that we have begun to take it for granted. Household debt has soared to nearly £1,100 billion (£1.1 trillion) and from 100 to 140 per cent of annual household income.

Most of that debt is in the form of mortgages. This spring, however, something curious happened. Consumers paid off more non-mortgage debt (credit cards and other loans) than they took out. Net borrowing fell. Was the penny dropping on debt?

We haven’t suddenly switched from being a nation of borrowers to being newly thrifty. Maybe, though, the past rise in debt is catching up on households. While the debt-serving burden remains low, because interest rates are modest. The picture changes dramatically once capital repayments are factored. On that basis the squeeze on indebted households is not far short of what it was in the early 1990s, when interest rates were two or three times present levels.

You write Britain’s consumers off at your peril. But what about that other question: What will take up the growth slack? That is not immediately clear. As Butler points out: “The global economy also has problems, which means the cavalry in the form of a strong export or investment recovery is unlikely to arrive.” A consumer slowdown may mean an overall growth slowdown.

One bit of good news in all this, of course, is that for once the interests of consumers and manufacturers are neatly entwined, at least in one important respect. In the past interest rates had to be higher than was comfortable for industry to keep rampant shoppers and homebuyers in check. That is no longer the case. Both firms and individuals need lower interest rates. With 4.75 per cent looking like the peak for base rates, they should get them before too long.

From The Manufacturer, June 2005

Comments

Just as we're starting to feel sympathy for consumers trying to cut the borrowing habit they go and blow it all on an extra billion-pound borrowing binge in May. (Total net lending to individuals in May was £9.8bn; over a billion more than in April):
http://www.bankofengland.co.uk/statistics/li/2005/may/lendind.pdf

The number of mortgage approvals has now recovered to sensible 90s levels. Surely there’s no point in encouraging more borrowing for speculation or entertainment by cutting rates at this stage.

Posted by: David Sandiford at June 29, 2005 11:15 AM