Believing in life after debt

Nothing has happened since the Budget to undermine the confidence the Chancellor expressed about the UK’s short-term prospects. Inflation remains low, unemployment keeps falling and GDP growth has been accelerating since the third quarter of last year. Even manufacturing seems to have turned the corner, with output edging up throughout 2003. Yet there are concerns, and they have been expressed not only by the press but by the Monetary Policy Committee and the Financial Services Authority.

The UK economy has bucked the global trend of slowdown and recession. Consumers were persuaded by the sweetener of lower interest rates, which fell from 6% at the start of 2001 to a 55-year low of 3.5% last summer – a drop of more than 40% in interest charges. With this sort of incentive, together with steady growth in earnings, spending rose, borrowing increased and savings dipped.

Borrowing certainly bought the UK economy time – the breathing space it needed until the global economy recovered. But it has come at a price.

Total consumer debt at the end of last year totalled £936bn, split between unsecured (credit cards, loans, overdrafts) of £170bn and secured (mostly mortgages) of £766bn. With a massive 82% share of the total, mortgages are the dominant element.

Just three years earlier, the equivalent figures for consumer borrowing were £535bn for secured and £127bn for unsecured, making a total of £662bn.

This represents an increase of 41%, over a period in which household incomes rose by a more measured 14.4%. Consequently, outstanding debt as a share of gross household disposable income jumped from 101% to a record 125%.

Although historically low interest rates suggest the debt is no more onerous now than it was (interest payments on the debt have been about 7-8% since 1999), there are fears that as debt continues to escalate and base rates move north, the consumer is becoming more vulnerable.

Official figures published in March reveal few signs of consumers slowing down. According to the Bank of England, lending to individuals rose at an annual rate of 14% in February this year, slightly faster for property-related borrowing than consumer credit. This bears out the Nationwide’s House Price Index, which recorded a 16.7% rise in the 12 months ending in March. A signal that this could well be sustained comes from the HSBC Index, which records all enquiries for new personal loans and mortgages throughout its network in England and Wales. These figures reveal a large household appetite for debt.

How concerned should policymakers be about these trends? The key, of course, is not how much debt there is, but whether this debt is manageable.

The Bank of England has looked closely at the distribution of debt and concluded that households with the highest levels of both mortgage and unsecured debt tend to have the highest levels of income and net wealth, although debt-to-income ratios were highest for low-income groups. In terms of unsecured debt, almost half the total is accounted for by 4.3% of the population, with individual debt in excess of £10,000. At the other end of the spectrum, close to half the debtors owe less than £1,000 and two-thirds owe less than £3,000. These numbers are reassuring in a macro sense, although some individuals will clearly be struggling to cope, and these are of concern.

On the plus-side is the fact that the steady rise in house prices has added to households’ notional wealth through increasing positive equity.

Against an average debt per employee of £25,000 (including outstanding mortgages), positive equity per household is now estimated by the Council of Mortgage Lenders to be about £80,000. As house prices move upwards faster than debt, this gap – and therefore households’ borrowing capacity – continues to widen. Although homeowners have larger debts than those who are renting, they have the comfort of an appreciating asset to underpin their borrowing.

All of this could come tumbling down, of course, if unemployment were to take off or interest rates surge (since debt is now broader and deeper, 7.5% would do the sort of damage today that 15% did in 1990). Not even the most pessimistic forecasters, however, are expecting these conventional triggers to spark a collapse in house prices.

The Budget, euphemistically described as ‘fiscally neutral’, suggests that more interest rate pain is in the pipeline for households. But given the inflation outlook, any rise is likely to be modest and a rerun of the collapse in personal finances of the early 1990s is not likely.

Dennis Turner is chief economist at HSBC.