UK Household Borrowing Reaches the Extreme as Markets Look to Bank of England For August Interest Rate Hike

-Household spending outpaces income for 1st time since 1988.

-Households spent £25 bn more than they earned in 2017 year.

-Data appears to support BoE concerns over debt sustainability. 

© Alice Photo, Adobe Stock

UK households spent more than their income in 2017 and borrowing hit a decade high, according to Office for National Statistics data, which appears to support arguments that interest rate rises from the Bank of England could be necessary to prevent an unsustainable build up of debt. 

Households spent £900 more than they earned in income last year, amounting to more than £25 billion of debt or savings funded spending, marking the first occassion when UK families spent more than their income since 1988. Although back then, the mismatch between income and spending was just £300 million.  

"We’re borrowing more and saving less partly because the interest rate – which dictates returns on money saved and the size of loan repayments – has been at or near a record low for the past decade. The base rate set by the Bank of England is just 0.5%, compared with almost 15% in 1990, making financial conditions better for borrowers rather than savers," the ONS says, in a recent announcement. 

The statistics office flags how the Bank of England has said recently that interest rates could soon begin to rise and suggests that household expectations of higher borrowing costs could even exacerbate the problem in the short term. 

"Borrowing could rise in the short-term as households seek to take advantage of smaller repayments, while saving could be put off amid the prospect of higher returns in future," the ONS explains. 

The BoE has warned repeatedly that rapid growth in consumer credit poses a threat to financial stability and that could take further action to stem the increase in this category of borrowing. It said in its June 2018 Financial Stability Report that consumer credit outstanding grew by 8.8% during the year to the end of April, down from a peak of 10.9% annualised growth during the year to November 2016.

"Despite a blip in March, consumer credit growth remains rapid, but the FPC and Prudential Regulation Committee have previously acted to help ensure lenders are able to absorb severe losses on consumer credit. Growth has slowed over the past year and lenders report a tightening of credit supply conditions," the BoE says. "The slowdown in consumer credit growth since its peak in late 2016 has been driven by car finance, where banks do not have material exposure. Personal loan and credit card debt continues to grow rapidly."

However, the question of whether higher interest rates will reduce borrowing over the medium term may depend on the reasons behind that increase in borrowing. If households are borrowing more in order to fund discretionary purchases such as consumer goods and holidays, then that borrowing and spending may be effectively stymied by rising interest rates.

But if households have used credit in order to fund essential expenditures, perhaps for reasons related to living costs or some other personal circumstances, then it may not be so easily subdued by an increase in borrowing costs. In fact, borrowing may even increase as households are compelled to take out loans at even higher rates.

"The Bank of England’s rate-setting grandees are determined to return interest rates to more normal levels, sooner or later. But it’s looking increasingly unlikely that they will be able to do so without getting blood on their hands,” says David Birne, an insolvency partner at chartered accountants HW Fisher & Company. “The number of people slipping into insolvency is up by more than a quarter on this time last year, and the quarterly casualty toll has risen to its highest level in six years."

The Office for National Statistics said itself last year that more than one in five households were in "poverty after housing costs" in almost half of "small areas in England and Wales" during the 2014 year. It defines "poverty after housing costs" as those households that earn £232 per week or less once their housing expenses are deducted from income.

Another ONS survey, the latest edition of Family Spending in the UK, showed that transport and recreational activities were the two largest and fastest growing categories of expenditure during the year ending March 2017. The transport category includes car and fuel purchases as well as spending on public transport, while the recreational category includes spending on holidays and "cultural activities". 

“With real wages still growing at almost negligible levels, many Britons’ finances are already stretched dangerously tight," says Birne. "Those who’ve been relying on credit to fund a more comfortable lifestyle – who are often the poorest and most vulnerable – are sitting ducks to interest rate rises."

Despite that price pressures have fallen much faster this year than economists had forecast, the Bank of England is still widely expected by the market to raise UK interest rates to 0.75% on August 02, 2018.This would be only the second rate rise since the financial crisis.

UK inflation held steady at 2.4% in June when economists had been looking for the consumer price index to rise to 2.6%, given a double-digit increase in oil prices this year. Core inflation, which excludes energy and food items from the goods basket measured, actually fell from 2.1% to 1.9%.

The BoE forecast in February, when the consumer price index was still at 3%, that it would remain above the 2% target until at least the first quarter of 2021. Changes in interest rates are normally only made in response to movements in inflation. 

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