August marks the anniversary of the Bank of England’s decision to cut interest rates and restart quantitative easing in the aftermath of the EU referendum result. Forecasts of an immediate downturn in the UK economy proved to be overly pessimistic and this resilience was attributed to UK households shrugging off the uncertainty created by BREXIT and maintaining their spending patterns. With household incomes remaining stagnant, a willingness to take on more debt has helped sustain consumer spending. The main consequence of this appears to be a sharp drop in the savings ratio – an estimate of the amount of money households allocate towards savings as a percentage of total disposable income. Economists recently sounded warnings after the ratio fell from 5.3% in the third quarter of last year to 3.3% in the fourth quarter. This marked the lowest level since comparable records began in 1963.
Unsecured consumer credit has expanded at double-digit rates for the past year so, giving rise to concerns of an unsustainable expansion in credit, particularly considering the disparity between credit growth and household income growth (which is struggling to keep pace with inflation and is therefore largely flat). However, a more positive theory is that households are confident enough to increase borrowings to help smooth consumption in the short-term.
Consumer spending in the last few months appears to have stalled however. Whilst it is too early to say whether this is a sign of a spending squeeze or other factors such as seasonality, Visa’s consumer spending index indicated that the April to June period was the worst quarter for spending since the third quarter of 2013. July data was also weak with Visa estimating that spending was 0.8% below that of July last year. Clothing, homeware and foreign holidays were notable losers on the back of weaker sterling. Some areas fared better than others did however. A projected increase in summer ‘staycations’ has bolstered to bolster the UK leisure industry, with hotels, restaurants and bars reporting strong sales in aggregate.
In August, credit rating agency Moody’s downgraded four of the five consumer finance sectors to negative in a report that highlighted the UK’s weak economic climate. According to the FT, it reduced its outlook for asset-backed securities based on auto loans, credit cards, buy-to-let mortgages and non-conforming mortgages that do not meet high street lending standards. It also suggested that lower-income households were especially vulnerable to a downturn.
Auto loans are an area where changing consumer behaviour has led to a build-up of outstanding credit, not only for households but also for the manufacturers themselves. The current popularity of Personal Contract Plans (PCP) is evident in the figures, with over 80% of new cars financed in this way. The increased churn and brand loyalty that they generate has become a crucial tool for the big manufacturers to maintain sales. This proliferation of leasing deals means that more and more used cars are hitting the market after the initial lease period. Prices in the used car market are an important factor when setting attractive lease terms; therefore, there is the potential for a vicious circle to be established.
A recent financial stability report from the Bank of England - whilst assessing the overall risks from the domestic environment to be at a standard level - did identify pockets of risk in the financial system that required vigilance or redress. The report suggested that these had come about due to benign conditions and a generally stable lending environment, which had prompted an element of complacency in some areas such as mortgage lending, where it noted looser underwriting standards employed to maintain mortgage growth.
Due to this highlighted increase in consumer credit, the regulator has brought forward an assessment of stressed losses on consumer credit lending to coincide with the 2017 annual stress tests, scheduled for release in the fourth quarter. Despite these precautionary actions, the Bank of England report states that the major UK banks have continued to strengthen their capital positions and exposure to weakening household finances in the domestic economy does not constitute a systemic threat to the financial system at present. The Bank also said it would keep in place measures introduced in 2014 that limit high-risk lending to 15% of a lender’s overall lending.
There are some additional capital requirements, which come in two phases; a 0.5% rise in a special pot of capital known as the countercyclical capital buffer in June 2018 and another 0.5% the year after that. Each 0.5% increase amounts to about £5.7bn of extra capital in the system and does not necessarily mean banks would have to raise fresh amounts of cash but rather reallocate existing capital.