Economics Weekly - Despite the credit crisis, debt accumulation still on going in the UK; Weekly economic data preview - Market events to overshadow data
Economics Weekly29 September 2008
Despite the credit crisis, debt
accumulation still on going in the UK
The credit crisis has resulted in less credit being made available
for households and companiesâ€¦
The credit crisis is still in full swing; in fact, it is worse
now than when it first started in Q3 of last year. Credit spreads have widened
out and interbank spreads are the widest that they have been at any time in the
last 12 months. But our focus in this weekly is on the fact that with credit
conditions tightening - a higher cost of borrowing and less credit being made available
- we should be seeing a significant reduction in leverage by households and
companies by now. But the data do not yet show that this is occurring; although
debt accumulation is slowing it is still taking place. Given currentevents in
financial markets, is it just a matter a time before it slows more sharply? We
look at some evidence of where we are currently in the analysis that follows.
â€¦but UK households are still accumulating debt faster than they are growing
UK households have accumulated a vast amount of debt since 1981,
but this accelerated particularly sharply from about 1997 onwards, see chart a.
During this period there was a dramatic fall in price inflation and so sharp
cuts in interest rates, which made it easier to obtain credit. But there was
also deregulation and a surge in the supply of credit, which increased the ability
of households to get access to loans. Also, employment reached a record high
and unemployment fell to a 35 year low as UK economic growth averaged 2.9%,
adding to the fast pace of growth of loans.
We think that a combination of the credit crisis and slower
economic growth will result in weaker growth in employment and a stalling of
the 10 year falling unemployment trend over the next few years. This will
result in a flattening in debt accumulation in the UK over the period to 2013, see chart a. But for that to happen,
growth in loans relative to growth in incomes must slow so that loan growth is
at least in line with income growth.
At present, as charts b and c show, although the credit crisis
has meant that loans are less available for mortgages and for unsecured credit,
there has only been a mild slowdown in the rate of borrowing of UK households. Indeed, looking at unsecured loan growth, it has
accelerated. This may be a bad sign if it suggests increasing use of this form
of credit to pay off debt on secured loans. Only time will tell, as we should
see higher default rates and ultimately a sharp fall in this form of borrowing
if that is the case. In the meantime, however, it is clear that the sort of
loan slowdown that one would expect
The same applies to corporate loan growth, see chart e, where
profit growth is less than loan growth, implying a rise in the level of indebtedness
of non-financial companies to lenders. This trend may, of course, be good news
for the economy as it implies that the negative feedback loop from a cutting of
loans to a cutting of spending by borrowers is not kicking in as much as many
fear, at least not yet. But it could be bad news if the economy enters a deep
recession, as debt defaults will likely rise to unprecedented levels.
â€¦and this is leading to a further rise in the UK's debt burden
though we think this trend will flatten in the years ahead as the economy slows
and less credit availability bites
Looking at growth in borrowing by households, which amounted to
about Â£1.4 trillion at end July 2008, currently accounting for some 170% of
annual income, it is still rising well in excess of growth in income, see chart
f. Indeed, breaking this total down into mortgage borrowing growth and
unsecured borrowing growth shows that both categories are rising faster than
income, meaning that the household debt burden as a share of income is still
rising. However, for both categories of household debt the pace of growth is
slowing, see chart g, and has slowed fastest for unsecured loans than for
mortgages (unsecured loan growth has picked up in the past year). This trend
needs to continue in order for the debt to income ratio to stabilise: in other
words, debt cannot rise faster than income. There is a possibility that
borrowing growth could fall below income growth if the credit crisis really
bites and if households take fright at rising unemployment as the economy
slows, and so increase their saving rate. Our central view, at present, is that
a combination of this occurs in the years ahead and household borrowing and
income growth balance for the first time in well over 20 years. This will show
up as a flattening in debt to income ratios, albeit at a high level, see chart
As said at the start, the evidence would suggest that loan
growth in the UK (company and household) is still faster than income growth so
the adjustment to a more restrictive supply of credit - at a higher cost, and
by fewer lenders - does not yet appear to be impacting borrowers as much as one
would have thought one year into the credit crisis. However, it may just be a
matter of time and, as the economy weakens, a slowdown in borrowing growth to a
more sustainable pace becomes ever more likely.
The European Central Bank (ECB) meets to discuss interest rates
on Thursday, amid intensifying financial market stress and growing signs of
weakening euro zone economic activity. However, these concerns will have to be
balanced with the still unfavourable inflationary backdrop, despite signs that
the annual rate may have peaked. Although we expect interest rates to remain on hold at 4.25%, the press conference from ECB
president Trichet could contain surprises. The US September employment report, on Friday, is forecast to show
that the US economy lost jobs for a 9th successive month. We look for a 90,000
decline, with the risk of a sharper fall. The unemployment rate will also
attract attention, after rising to a five year high of 6.1% in August. A
disappointing report will raise speculation of a cut in US interest rates.
However, we believe interest rates are already low at just 2% and a further
reduction will have only a limited impact on the credit crisis and current
â€¢ UK data his week will provide further clues to whether the economy
has entered recession. We forecast the UK will skirt recession this year, with any quarterly contraction
likely to be relatively modest should it occur. The final estimate of Q2 UK
gdp, on Tuesday, may provide a surprise, if growth is revised from unchanged
over the quarter. While we believe there is a risk on either side, given recent
economic data, the most likely outcome is for no change. But a large scale
revision of the method of calculating gdp has been underway and the results of
this could lead to a surprise. Any contraction would be the first since 1992
and will raise market speculation of interest rate cuts, possibly as soon as
next week. However, we remain of the view that the majority of the MPC will want
to wait for clearer signs that inflation has peaked though the worsening credit
market conditions will raise the risk of a cut in rates. A sharp slowdown in
economic growth is ultimately required to increase spare capacity and bring
inflation to target over the Bank's two-year horizon. However, the
destabilisation of money markets and generalised tightening in credit
conditions - UK 3- month Libor is up more than 50bps since the September MPC
meeting. A further deterioration in credit conditions ahead of the next MPC
meeting could shift the balance of risks to growth from inflation.
We expect the PMI data this week to show both services and
manufacturing activity contracted in September. However, the headline indices
should remain close to levels broadly consistent with slow to stagnant economic
growth. The retail sector, which has been surprisingly buoyant of late, is also
not covered by these indices. We remain of the view that UK Q3 gdp growth could
be slightly positive. Lending figures published by the BoE this morning are
likely to show a further fall in mortgage approvals and net mortgage lending in
August. This should come as no surprise given the significant tightening of
household credit conditions and weakening sentiment about the housing market,
and suggests that further falls in house prices are likely in the months ahead.
However, net consumer credit may have picked up, possibly to a six month high
of Â£1.3bn, from 1.1bn in July
â€¢ The economic landscape in the US continues to be dominated at present by bank failures and the
much publicised $700bn rescue package to remove illiquid mortgage backed assets
off banks' balance sheets. However, with Congress close to agreeing a compromise
over the weekend, attention should soon return to the real economy. Economic
data last week highlighted the risk of a relapse in Q3 gdp growth, with
business investment and housing markets registering weak demand. The rise in
weekly unemployment claims last week to 492,000 suggests that the labour market
picture is also darkening. The September employment report is due this week and
may add to market perceptions that the Fed will cut interest rates, possibly as
soon as October 29th. We are not convinced. The US consumer confidence index, ISM surveys and personal income and
spending data are also published this week.
â€¢ The ECB finds itself in a very similar position like the BoE,
with monetary policy currently being dictated by high inflation and rising fears
about economic growth. However, challenging credit markets, worsening
forward-looking indicators and signs that inflation has peaked, suggest that
the ECB could soon switch its stance on interest rates towards an easing bias.
The main data highlights this week are the 'flash' estimate of September CPI
and EU-15 retail sales in August.
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