Rise in unemployment to halt consumer debt binge, say economists
The amount we are squirrelling away is at an all-time low, but should carefree consumers think again, wonders Szu Ping Chan
SAVINGS should start to rise and debt levels fall back as Britons finally start to end their latest debt binge, according to forecasts from the National Institute for Economic and Social Research (Niesr).
Consumer credit has been surging with growth rates of more than 10pc per year, while the savings ratio – the amount of money put aside as a proportion of income – fell to a record low of 1.7pc in the first three months of 2017.
But households will be jolted out of their complacency by a slowdown in the economy and a possible rise in unemployment, making them save more keenly, new forecasts indicate.
“Our view is that consumer spending will be squeezed and households will look to start rebuilding savings from here,” said Amit Kara, Niesr’s head of UK macroeconomics research.
“We have a modest rise in unemployment in our forecast and, historically, a rise in unemployment has been accompanied by higher savings. There are, of course, huge risks around this view, including the possibility that consumer spending powers ahead and household saving falls further.”
He expects savings to pick up a little over the rest of the year, leaving the ratio at 2.8pc over 2017 as a whole.
That is forecast to rise to 4.8pc in 2018, 6.5pc in 2019, 7.7pc in 2020 and 8.4pc in 2021 – the highest level since 2011. “By 2021, we expect households to be net lenders to the rest of the economy of 0.1pc of GDP,” Niesr forecasts. However, there is a risk to the wider economy if households all cut back their spending at once in an effort to shore up their savings levels.
“The risk still remains that if households feel that they’re overextended, there is a concern that they will start to save more abruptly, and this will lead to a further downturn in the economy,” said Jagjit Chadha, Niesr’s director. “Some of the consumption robustness we saw in 2016 and the early part of this year was very much driven by credit, very much driven by the [Bank of England’s] term funding scheme, and the availability of unsecured credit for households.
It’s meant to be a sign of confidence. British households have been saving less than ever before, following a period of robust real income growth and increased optimism about their finances. Official data show the saving ratio – which measures the amount British households have available to save as a share of total disposable income – dropped to 1.7pc in the first quarter of 2017, down from a previous low of 3.3pc at the end of 2016.
This is the lowest since records began in the Sixties.
But Britons cannot live beyond their means forever. The head of Britain’s fiscal watchdog warned in March that there are limits to how low the saving ratio can go.
Robert Chote, chairman of the Office for Budget Responsibility, said it was a matter of arithmetic. “This pace of decline cannot continue indefinitely and we don’t assume it does,” he said.
Consumers usually dip into their savings when they believe sunnier days are ahead and are confident about their earnings potential.
For example, in the run up to the financial crisis, the saving ratio – excluding pension contributions – was negative between 2004 and 2008.
But booms can quickly be followed by busts. And when consumers start to feel nervous about their finances, the prospect of a rainy day usually prompts higher saving.
For an economy that relies on consumer spending to drive two thirds of economic output, retrenchment inevitably means lower growth.
Sir Charlie Bean, a senior official on the OBR, has compared the British consumer to Wile E. Coyote, the Looney Tunes cartoon character who chases the Road Runner off a cliff, before succumbing to gravity and being brought back to earth.
He says strong consumer spending at the turn of the year was partly down to the benefits of a couple of years of low inflation.
“The economy didn’t fall off a cliff after the referendum vote and we’ve had a couple of years of good real income growth, and that is projecting a Wile E. Coyote situation when eventually consumers realise that the squeeze in real incomes is coming through.”
Just like Wile E. Coyote, Sir Charlie believes consumers can quickly cut back spending in response to a perceived slowdown.
For example, the saving ratio more than doubled between 2008 and 2010 to 11pc, at the same time as the UK economy contracted by 6.1pc from peak to trough.
The big question for the economy, says Sir Charlie, is if other elements of spending, such as investment, can offset more sluggish growth in consumer spending. Behind the numbers The decline in the saving ratio has triggered fears that Britons have been raiding their savings or embarking on a debt binge in order to maintain their living standards. Recent data suggest a more mixed picture.
To understand what’s going on, it is important to look behind the headline figures.
The saving ratio is calculated as a share of lots of different bits of income. Salaries make up the bulk of this, accounting for just over half of total household income as measured by the Office for National Statistics (ONS).
A further quarter is represented by income earned from private pensions, as well as state benefits. Dividend and interest payments make up another sizeable chunk.
But “household income”, as measured by the ONS, also includes bits that Britons can’t spend straight away, such as the returns on investment by pension funds and insurance companies.
This is important, because at the end of last year, the ONS said the drop in the saving ratio to 3.3pc in the fourth quarter of 2016, from 5.3pc in the previous quarter, was driven by weaker returns on investment rather than a spending binge.
While the decline in the first quarter of 2017 reflected “relatively strong consumption volumes, increasing consumer prices and subdued wage growth”, higher tax payments also ate into disposable incomes, the ONS said.
The ONS is also improving the way it calculates the ratio following new EU rules and broader changes that reflect modern ways of work.
Currently, data from charities, churches, trade unions, and universities are included in the headline saving ratio.
New calculations are expected to lower the household saving ratio by around 0.5 percentage points per year between 1997 and 2012, according to preliminary ONS estimates. However, a rise in self-employment since the financial crisis means more Britons rely on dividend payments for income, instead of paying themselves as employees.
Recent HMRC data show households are getting more of their income from dividends than previous ONS estimates suggest.
In a recent economic bulletin, Britain’s statistics office said: “As the level of consumption of goods and services is unchanged, this higher income means that households have been saving more and therefore that the savings ratio is higher than previously thought.”
The ONS estimates higher dividend payments will increase the saving ratio by an average of 1.3 percentage points a year between 1997 and 2012.
The net result is that households are in a less precarious position than previously thought. More recent data published later this year should push up the saving ratio even more due to the surge in self-employment, according to the Bank of England.
“Since an increasing number of the self-employed have become incorporated after 2012, all else equal, it is likely that household income will be revised more significantly in recent years,” it said in May.
But while we’ll have to wait for the official data, it’s clear that the behaviour of the British consumer will have a considerable impact on the UK economy. Consumer boom or bust? Back in March, the OBR took a closer look at the impact of a consumer boom on the UK economy. Under this scenario, households would keep splashing the cash in the face of the current real-income squeeze. This would drive down the saving ratio even further, pushing up growth and inflation. This would then prompt the Bank of England to raise interest rates to keep a lid on price growth.
Stronger growth today would be followed by weaker growth tomorrow, with a sharper medium-term slowdown forecast.
Growth would hit 4pc in the 2017-18 financial year, while higher tax receipts would push down the budget deficit at a faster-than-expected pace. However, growth would then slow to an annual pace of around 0.7pc by the end of the decade.
By contrast, under a “consumer bust” scenario, where households become cautious about the economy, squirrel more of their income away and push the saving ratio back to 7pc, the UK would fall into recession by next April, forcing the Bank of England to slash interest rates into negative territory. Growth would then recover, but tax receipts would be weaker than its central forecast.
While the Bank and OBR expect the saving ratio to stabilise, leading to a gradual slowdown in growth, Jagjit Chadha, director of the National Institute of Economic and Social Research (NIESR), says the risk of a sharper slowdown remains.
“If households feel that they’re overextended, there is a concern that they will start to save more abruptly, and this will lead to a further downturn in the economy,” he says.
As the Bank of England highlighted last week, productivity remains the key to unlocking higher living standards.
As Sir Charlie puts it: “Consumption growth at this sort of rate is only going to be sustainable if real income growth picks up, which in turn needs productivity growth and real wage growth to pick up.”