Sunday, May 14, 2017
Our nation of borrowers is storing up trouble
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

The governor of the central bank was perfectly clear. High and rising household debt “has made the economy less resilient to future shocks”. It is more likely that, in future, households will respond to an economic shock, or a rise in interest rates, by cutting their spending more sharply than in the past.

“Double-digit growth in debt … at a time of weak income growth cannot be strengthening the resilience of our economy,” he added.

This was not, for once, Mark Carney, but his Australian counterpart, Philip Lowe, governor of Australia’s Reserve Bank, in a speech a few days ago to the Economic Society of Australia, but the parallels with Britain are close.

The good news is that we are not alone in the vulnerabilities and challenges that high levels of household debt, alongside high house prices, pose. The bad news is that household debt in Britain, £1.53 trillion on Bank of England figures, higher on other measures, is higher in relation to income than in most other countries, as are house prices.

The Bank, for its part, has expressed its concern over the rapid growth in consumer credit, currently rising by more than 10% a year, its fastest since before the financial crisis. In its latest inflation report, published on Thursday, the Bank noted that the Prudential Regulation Authority is looking into whether credit quality is suffering, while the Financial Conduct Authority is examining assessments by lenders of the creditworthiness of borrowers.

Figures on Friday from the Finance and Leasing Association showed £5bn of car finance – new and used – in March, up 14% on a year earlier. Over the past 12 months, consumer car finance has totalled £32.6bn. Though this sharply rising debt is mainly on the books of finance companies and the motor industry, with 86.5% of new cars bought with finance it represents a significant monthly payments’ burden for households.

The bigger picture is what high levels of household debt mean for the stability of the economy and, for central bankers, whether they tie their hands when it comes to future interest rate hikes.

The numbers, for Britain, are striking. In the 1980s, after credit controls were abolished as part of a wave of financial liberalisation, concerns were expressed over high levels of household borrowing. Back then, however, we were merely in the foothills. Household debt in 1987 was £185bn. Including both mortgage and non-mortgage borrowing. Thirty years on it is more than eight times that, and has trebled relative to incomes.

The question of what to do about high household debt is one of the questions posed by Jagjit Chadha, director of the National Institute of Economic and Social research, in his introduction to the institute’s latest quarterly review, which has just been published.

Chadha, looking at the challenges the income government, which I guess will be led by Theresa May, not a very bold guess, will face after June 8, apart from you know what, makes the good point that household debt has to be balanced against much higher household wealth. But he notes that the composition of household wealth has become skewed toward housing; 45% of wealth now compared with 32% in the mid-1990s. Not only that, but those who have the wealth are often very different from those racking up the debt. The Bank’s figures for household debt do not include student loans, currently heading up towards £100bn.

I have always been more relaxed than others about household debt. One reason was the aggregate balance sheet; household wealth being always several times the level of debt. The other was that, until relatively recently, a healthy and necessary adjustment had been taking place. So, as recently as late 2013, the cash total for debt held by households was lower than its pre-crisis peak, meaning that debt had fallen both in real terms and relative to income. In Acacia Avenue and elsewhere, the message seemed to have sunk in: too much debt is bad for you.

Since then, however, there has been a change, most dramatically for unsecured borrowing. Debt is rising again, even before the memories of the crisis have faded. Some of that is demand – people have felt confident enough to borrow – and some supply; the lenders have been turning the credit taps on.

The process has been helped along by falling market interest rates.
It is, says Erik Britton, managing director of Fathom Financial Consulting, a familiar pattern, witnessed in Japan and elsewhere. Any pauses in the rise in debt are short-lived. Ultra low interest rates in response to recession and crisis eventually encourage more debt to be taken on.

The problem for central banks, Britton argues, is that they get themselves into a position in which relaxing monetary policy – cutting interest rates further – has little effect but raising them, even by a small amount, would have a significant negative effect because of high levels of debt.

Are we there yet? Though Britain is in the middle of a significant consumer slowdown , notwithstanding an Easter-related retail sales bounce, there is no sign of panic. The Bank, in its new inflation report, expects 1.75% growth in consumer spending this year, slowing to 1% next. In the 10 years leading up to the financial crisis, spending rose by an average of 3.5% a year.

Consumer confidence and employment are high, however, and despite the squeeze on real incomes currently coming through, there is no sign yet that fears of unemployment and being unable to keep up the payments are resulting in the feared sharp drop in spending. That would only happen if consumer became as gloomy about their own prospects as the surveys show they are about the economy, and that is not yet the case. It could become so.

That leaves high household debt as a constraint on interest rates. The central message in the Bank’s inflation report was that markets were too relaxed about the prospect of rate hike; not immediately but in 2018 and 2019. The Bank signalled that if things develop in line with its latest forecast, it would not expect to keep rates on hold until 2019, which markets had been expecting.

It is a reasonable message, albeit one reliant on a punchy forecast of a near-doubling of the rate of growth of wages (average earnings) over the next couple of years. It would enable Carney to leave the Bank in mid-2019 with a rate hike or two under his belt.

The crunch would come if there was greater urgency to push rates higher, because inflation had become more ingrained than the Bank feared. The Bank, with its annual survey of the financial position of households, carried out by NMG Consulting, is aware of the potential vulnerabilities. Some households, though only a minority, would be plunged into financial distress by even a modest rise in interest rates.

A modest rise, at best, is all that is in prospect in coming years, with the Bank aiming for a new normal for interest rates of 2%, though not for some time. But if debt continues to rise, even that could be too high for too many.