https://www.flickr.com/photos/leyla_arsan/ Leyla.aThe UK economy is stronger than we thought, but a question still hovers. If UK interest rates are set to rise, can indebted households survive higher interest rates?
The simple answer is that it depends. Higher rates are affordable, providing they don’t rise too high.
But let’s look at the data.
We already knew that the UK economy grew by 0.3 per cent in Q2 – that was a lacklustre performance, putting the UK near the bottom of both the EU and G7 for economic performance in the first half of the year.
What was especially, worrying was that indebted households were funding what little growth there was, which was clearly not sustainable.
But the ONS – that’s the UK’s official compiler of statistics – has been revising. It has revised its data on how the UK did in Q2, and also revised data going back further, in particular being more rigorous in how it measures income from dividends.
And the result: UK GDP estimates have not changed, but UK households have been saving more than we thought. It turns out that UK households were saving 0.9 percentage points a year more between 1997 and 2016, than we thought. And in Q1, the savings ratio was revised up from 1.7 to 3.8 per cent. As it happens, this is still quite low compared to much of Europe, but then the UK is different – for one thing, high house prices seem to justify higher household leverage, at least they do in the eyes of many people. What this means is that the UK consumer has greater capacity to support the UK economy than was thought.
There was more good news, the estimate of business investment in Q2 was revised upwards from zero growth to 0.5 per cent, while the estimate of UKs trade was also revised upwards.
Then again, before the release of this improved data, the Bank of England governor, Mark Carney, had already suggested that a hike in UK interest rates was close – it may even happen later this month.
But would such a hike be affordable? The last few years, has seen UK unsecured debt surge, while the Bank of England owned regulator, the FCA, has already warned that consumer debt is rising dangerously high. To make matters worse, in August, consumer credit increased by £1.6 billion against expectations of a sharp fall.
The good news is that unsecured debt as a percentage of income is lower today than in 2008 – roughly 16 per cent today versus over 20 per cent in 2008. But credit card debt, on the other hand, as a percentage of income is hovering around an all-time high.
On the other hand, look at debt servicing costs as a percentage of income, and you find that although this has risen in the last few years, it is around a third lower than in 2008 and similar to the levels seen in 2003.
After the Brexit vote, the Bank of England cut interest rates from what was then an all-time low of 0.5 per cent to 0.25 per cent. A return to half a per cent will make very little difference. Even if rates return to one per cent or slightly higher, households are likely to shrug this off. But, in the US, many expect rates to rise to three per cent or more, if the UK follows suit, then indebted consumers may feel pain, just bear in mind that almost every recession has followed a run of interest rates hikes.
