Monday, August 13, 2007
Grey big spender
Posted by David Smith at 10:00 PM
Category: David Smith's other articles

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I’ve spotted them, and don’t think I haven’t. Hanging around Marks & Spencer eyeing up the beige cardigans. Browsing through the gardening books in Waterstone’s. Sucking on Werther’s Originals.

That’s enough product placement in the column for this week – the Werther’s should be sent to the usual address – and that’s enough insulting clichés directed at older people. I’ll be joining them one day; some say I already have. At the very least I must have broken a couple of age-discrimination laws already.

But I have been thinking about whether older folk hold the solution to what is a bit of an economic puzzle. The puzzle is the resilience of consumer spending and, for that matter, the housing market in the face of rising interest rates and stagnant incomes.

Consumer spending rose by 3.1% in the year to the first quarter and appears to have continued reasonably strongly since, albeit with “tentative” signs of a slowdown, according to the Bank of England’s inflation report. This is hard to square, on the face of it, with a rise of a mere 0.3% in real household incomes over the latest 12 months. With the household saving ratio at a 47-year low of 2.1%, spending appears to be defying gravity.

The outlook for spending is very important. The Bank believes the economy grew by a speedy 3.5% over the past year, compared with the Office for National Statistics’ estimate of 3%.

This was the first time the Bank has explicitly published its own estimate as opposed to merely hinting that the ONS might be understating things. Growth over the past year would not have happened without solid growth in consumer spending. So where has it been coming from?

The obvious reason why spending has been stronger than expected is that the pass-through effects from the Bank’s rate rises to households are far from complete. When the monetary policy committee presses the button on a rate hike at noon on a Thursday it would be nice to think there was an instantaneous jolt to the finances of every household in the country. But the wheels of policy grind rather slower than that.

Last week’s inflation report, which I thought was measured, and certainly not hawkish, gave some of the detail. The first four rate rises since August last year amounted to 100 basis points (one percentage point) of tightening. By the end of June, the average mortgage rate had gone up by 51 basis points and the average rate on unsecured borrowing – consumer credit – had risen by only 39 points.

This is because a high proportion of borrowing is on fixed rates, which does not respond quickly to changes in short-term interest rates, and because lenders continue to compete for business. Interestingly, while lenders are always getting hammered for not passing on rate rises to savers, deposit rates have risen by slightly more; by 60 basis points in the case of instant-access accounts, and 88 for notice accounts.

In one respect therefore, the coming spending slowdown is just a matter of time. Those signs that the Bank sees as merely “tentative” should get stronger as we move into the autumn and the full effect of higher rates comes through.

But another number jumped out at me from the Bank’s inflation report. This was that while gross interest payments have increased by more than two percentage points as a share of posttax household income over the past four years, interest receipts have risen by 1.5 percentage points.

Given that higher interest rates essentially transfer cash between households – those with debt pay those with savings, with the banks taking their cut – this should not surprise us. Monetary policy works because borrowers have a higher propensity to spend out of income than savers.

In Franco Modigliani’s famous life-cycle hypothesis, we reach our peak for saving in middle-age through to retirement, saving little when young and drawing down savings, through pensions, in retirement. We tend to think of older people struggling to eke out their modest incomes.

But what if that has changed? Many of today’s overfifties have never had it so good. Their houses, on which they probably do not have a mortgage, have gone up enormously in value. They may be the last generation to enjoy really good company pension schemes. Their health is better than ever before. Many of them take great pleasure in skiing (spending the kids’ inheritance). They love rising interest rates and hate inflation, as my postbag testifies.

This “golden generation” own some three-quarters of Britain’s net wealth, some £5,000 billion, according to a report by Abbey earlier this year. The success of companies like Saga suggests they are not prepared to go meekly into beige-cardigan old age. Some of their savings get recycled, probably not entirely willingly, into house deposits for their children.

The spending power of the greys is not purely related to savings. In the past two years employment among people past normal retirement age (60 for women, 65 for men), has grown by nearly a sixth to more than 1.2m. Employment in this age group is growing faster than any other.

Not far behind are the 50-pluses (those between 50 and normal retirement age). Employment in this age group has risen by 65,000 to nearly 6.5m in the past year. Before people write in, I know we haven’t eliminated age discrimination in the workforce, and I have probably broken another law by referring to “normal” retirement age. But something is stirring.

Anecdotally, some of the rise in employment among older workers reflects those who have taken early retirement from their first career, and receive both a pension and the salary from their new job.

Does this mean we will not see a spending slowdown? In the end I suspect the traditional mechanism will work, and we are seeing just a delay in the full effect of rate rises coming through. Retailers, having ended their summer sales, can look with some nervousness to the autumn. But one man’s meat is another’s poison. Rising interest rates, like rising houses prices, are an inter-generational transfer from the young to the old.

PS: Amid the turmoil in financial markets, which continues, other markets aren’t working as well as they should be. The route to cutting greenhouse-gas emissions lies with properly functioning carbon markets. Last week Open Europe, the think tank, highlighted failings in the EU Emissions Trading Scheme, intended to be Europe’s carbon market.

Markets need good information. Investors have to know the quality of what they are buying and the risk attached to investments; institutional investors can often act only when in possession of such information. That is why we have agencies, rating corporate and sovereign bonds from AAA down to junk status. So far, however, there has been no similar rating system in place for carbon markets. If investors buy into a project or fund on the basis of promised emission reductions, they have had no way of knowing whether the promises are worth the paper they are written on.

That is changing. Sir Nicholas Stern, author of the government’s influential report on the economics of climate change, will soon join Ideaglobal as vice-chairman, to front a service that could transform carbon markets.

Idea, known for its risk research in financial markets, will provide a rating service for carbon projects and funds and has already assessed half a dozen. An AAA project will be almost guaranteed to achieve its emission-reduction goals.

For its carbon division, Idea has also recruited Ian Johnson, former head of the World Bank’s carbon finance unit, and Sam Fankhauser, former deputy chief economist at the European Bank of Research and Development, who was part of the Intergovernmental Panel on Climate Change (IPCC).

Carbon markets could be incredibly important in the coming decades. This initiative could help turn the hot air sometimes talked by governments about reducing emissions into a reality.

From The Sunday Times, August 12 2007

Comments

Again, the housing market is devoid of supply and that works against the principle of rising interest rates having an effect on house prices. The house prices will keep on ballooning as long as supply is restricted.

The MPC is staying put so as to look closely at the GDP numbers which is part of their concern and in no hurry to hike up to 6% as yet....and rightfully so. It makes life a bit more difficult for them having to juggle between inflation and growth, especially in the case of the current market turmoil in sub-prime which is extending into hedge funds. This will probably have an impact in the UK funds and so far, we have not seen any fund owning upto to losses or future losses.

We have to keep our fingers crossed with what the next two months hold for GDP growth rates and hope that we grow with the trend so far.

Posted by: Hitesh Damani at August 14, 2007 01:38 PM