By Leith van Onselen
It’s starting to turn pear-shaped for the United Kingdom (UK) economy. Last week, the UK slid deeper into recession, with GDP falling -0.3% in the first three months of 2012 on an annualised basis, following a -1.2% annual rate of decline in the final quarter of 2011 (revised down from a previously reported -0.8% annual decline).
Unemployment has also risen in the UK recently, increasing by 0.5% over the past 12 months to 8.2% as at April 2012:
One of the key issues facing the UK economy is that it is saddled with far too much debt, as illustrated by the below chart from McKinsey Global Institute:
In the years leading up to the Global Financial Crisis (GFC), the UK economy was turbo-charged by a positive feedback loop between rising asset values and consumer confidence, and increased borrowing, household expenditure and employment.
In a nutshell, the rapid rise in UK household net worth up until 2007, most of which was on the back of rising home values, led to households withdrawing large amounts of home equity between 2001 and 2008, which provided a boost equivalent to 3% to 9% of disposable incomes (see below chart). Much of this borrowing was spent on consumption, which in-turn further boosted incomes and employment.
However, as soon as the GFC, and UK housing prices corrected, households began reducing consumption and repaying debt, as evident by the increasing home equity injection.
It’s a case of the positive feedback loop, described above, working in reverse. That is, with home prices falling, UK households suddenly felt poorer, eroding consumer confidence and their willingness to spend (the ‘wealth effect’). And with asset prices falling, and many households moving into negative equity, they had little choice but to tighten their belts and begin the process of debt repayment, thus crimping consumption expenditure, incomes and jobs (see below charts from Delloitte).
The shift from borrowing (consumption) to saving has occured despite UK mortgage rates falling sharply since the GFC:
And UK housing affordability improving significantly:
The below analysis of the British Bankers Association’s (BBA) latest consumer credit data by IHS Global Insight highlights the cautious mood of UK households [my emphasis]:
The BBA reported that there was a renewed net repayment of £198 million in unsecured consumer credit in April. While this followed a small increase in consumer credit of £96 million in March, it was the seventh net repayment in nine months.
There was marginal net borrowing of £8 million on credit cards in April, while there was a significant net repayment of £206 million in personal loans and overdrafts.
The net repayment in consumer credit in April ties in with the marked falling back in retail sales.
The renewed net repayment of consumer credit in April indicates that consumer appetite for new taking on new borrowing remains limited while there is also an ongoing strong desire of many consumers to reduce their debt.Consumer desire to keep a tight grip on their finances is clearly the consequence of still serious concerns over the outlook for the economy and jobs. Indeed, it is very possible that increased worries over the outlook resulting from news that the economy is back in recession and from the situation in the Eurozone may well intensify the desire to improve personal finances.
This is also evident in the BBA reporting that net mortgage lending was limited to £715 million in April as “capital repayment by householders remained at a high level”. This suggests that house owners are looking to take advantage of low mortgage interest rates to reduce their outstanding mortgage levels to improve their balance sheets.
The UK experience should give pause to those commentators expecting interest rate cuts from the RBA to stimulate housing and consumption.
While lower interest rates should, in ‘normal’ circumstances, help in stimulating demand, they prove less effective when asset (housing) prices are contracting and a deflationary mindset has taken hold. In such circumstances, indebted households are just as likely to use the extra disposable income from lower mortgage rates to pay down debt, whilst those households reliant on fixed interest for their income (e.g. retirees) will find themselves with less money to spend.