Granted, total consumer spending has been weaker – it has fallen 3.9 per cent since Q4 2007 – but nevertheless, this resilience draws attention to the fact that the much-discussed household deleveraging has not actually happened.
I say this because households’ total financial liabilities are slightly higher now than they were at the peak of the boom in 2007Q4 – at £1.54 trillion versus £1.52 trillion. Yes, the ratio of liabilities to annual disposable income has fallen from 174 to 147 per cent, but this is because inflation, rising employment and higher welfare payments have raised incomes, not because households have in aggregate reduced their debt.
Herein lies one of the great uncertainties: will this fall in the debt-income ratio continue? The OBR thinks not. It expects the ratio to fall only slightly in the next few months, to 145 per cent, and then to rise. However, Danny Gabay at Fathom Consulting believes the ratio “has much further to fall”.
Clearly, much hangs on this. If the OBR is right, then consumer spending should contribute to the recovery; it’s forecasting a 6.6 per cent rise over the next four years, helped by a fall in the savings ratio. But if Mr Gabay’s right, the outlook isn’t so bright.
There are (at least) five reasons for such uncertainty.
■ There’s no precedent to guide us. Before 1980, credit controls kept households’ debt below its desired levels, and after 1980, the debt-income ratio steadily rose, except for a small fall in 1992-93.
■ The fact that households haven’t in aggregate paid off debt yet doesn’t mean they don’t want to. It could be that a combination of habit formation and the squeeze on real wages has meant they have been unwilling to do so. There’s no point reducing your mortgage if it means being unable to pay your electricity bill. It is only when incomes start rising, giving households more option to pay off debt, that we’ll see how keen they are to reduce their debt.
■ We don’t know what the optimum debt-income ratio is, because it depends upon something unobservable – namely, households confidence in the future.
■ Aggregate data disguise big variations among individuals, and it is the latter that matter. A debt-income ratio of 147 per cent is, in itself, perfectly sustainable; few people with a mortgage of 1.5 times their post-tax salary would consider themselves over-extended. But the problem is that a few people have debt of four, five or more times income. And it is their behaviour that matters. A recent survey by the Bank of England found that 12 per cent of households are “very concerned” about their debt. If these were to cut spending by, say, 20 per cent, it would take 2.4 per cent off aggregate spending, even though most households aren’t struggling with debt.
■ What will happen when interest rates rise? One factor helping indebted households stay afloat has been that they’ve been subsidized by low interest rates. If these households see their incomes rise as the economy recovers, they might be able to cope with a rise in interest rates. If not – and remember that economic recoveries are wholly consistent with many people not enjoying better times - then we could see a forced deleveraging, as they go bankrupt and their debts are written down.
In these ways, the old cliché is true – these really are unusually uncertain times. For years, forecasting consumer spending has been quite easy; it’s forecasting their incomes that’s been the problem. Now, though, the link between incomes and spending is not so clear. And this introduces an extra dimension of uncertainty into the economic outlook.
