Standard Life Investments

Weekly Economic Briefing

UK

Raiding piggy banks

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One of the big questions around the UK economy going into 2017 was; will households be prepared to neglect their piggy banks in order to prop up spending in the face of rising inflation? Initial estimates suggested that consumers were very happy to use savings to absorb as much as possible of this shock (see Chart 4). Indeed, the saving rate seemingly plummeted rapidly and alarmingly to below 2% in the third quarter - a record low. However, these data can be fickle. The Office for National Statistics (ONS) has released updated estimates of consumer income growth in its latest Blue Book, reflecting stronger household dividend income as rising numbers of people incorporate and take their pay in this form. This revision pushed the saving rate noticeably higher over recent years. The revised data now tell a subtly different story. Consumers have still lowered savings, in order to partly offset the inflation squeeze. However, this decline has not been as precipitous as feared, pointing to a more restrained balance sheet response. Indeed, barring any more surprises from the ONS, it looks like they used a combination of lower spending and saving in the face of the inflation headwind.

Rewriting history Balance repair sheet

The preparedness of households to reduce savings, even as we move towards Brexit, should not perhaps come by surprise. While growth has slowed this year, the worst fears around the impact of the EU referendum have not been realised. Moreover, the labour market has performed strongly. Indeed, while employment growth has softened recently, the headline unemployment rate has fallen to multi-decade lows. This reduces the perceived need for households to lower precautionary savings. Finally, household balance sheets have improved significantly over recent years. Household net worth, which measures the balance of total financial and non-financial assets and liabilities, increased to over seven percent of net income last year (see Chart 5). This improving financial position has likely emboldened consumers to be less cautious, even in the face of a still uncertain outlook.

The outlook for savings still remains one of the key issues for the UK economy. Despite the upward revisions to household income, savings are still low from a historical perspective. This does not mean that they could not fall further, but it limits the scope for lower savings to underpin consumption. Tightening credit conditions could also put a limit on the ability of households to bring savings lower. The Bank of England (BoE) has repeatedly expressed concerns over the robust trends in consumer credit; with credit card, personal loan and car finance debt all rising over recent years. It can influence this behaviour not just through its monetary policy settings, which have started to tighten very slowly, but also macroprudential regulation. Indeed, there are already signs that UK banks have started to take a more cautious attitude towards consumer credit, following repeated warnings from the BoE around the risks in this sector. The latest credit conditions survey suggested the largest tightening in credit conditions on unsecured credit since the financial crisis. If this translates into weaker lending then households will find it hard to supplement spending through this channel, leaving real income growth as the predominant driver of spending. Unless we see these incomes boosted by an improvement in anaemic productivity, households may have to get used to buying less.

James McCann, Senior Global Economist, Standard Life Investments