Households are increasing their borrowing in order to maintain their standard of living

"Households are increasing their borrowing in order to maintain their standard of living"

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We revised our forecast for UK economic growth up by 0.3 percentage point per annum this year and next, with a third of that due to changes to the past. So an upgrade of 0.2 percentage points doesn’t really change our outlook but the reason we’ve done it is that this pick-up in consumer spending over the last couple of quarters has come despite wage growth still lagging behind the rate of inflation.

What we’ve seen is the savings ratio drop quite sharply since the middle of last year and we expect that to remain low over the course of this year, supporting consumer spending growth. However, it is unlikely to continue into next year so what we expect to see is the saving ratio beginning to rise back up but this downward pressure on consumer spending growth is expected to be more than offset by a pick-up in real consumer incomes; itself a consequence of a slowdown in the rate of inflation rather than strong wage growth.

That doesn’t really change the pattern of muted growth. If you look at the year-on-year rates of growth, by the end of this year you’re getting towards what looks like a relatively weak recovery but overall it’s not robust economic growth.

Furthermore, the savings ratio story also points to one of the main short-term risks to our forecast. It might well be that the fall in the savings ratio bounces back up rather quickly. For example, some have already suggested that some of it could reflect the impact from the shifting of incomes to take advantage of the reduction of the top rate of income tax at the start of 2013Q2.

If it is just a blip and the savings ratio jumps back up to close to where it was last year and real income growth evolves as we expect, then growth in 2014 would be running closer to 1%, rather than our 1.8% central projection. 

Why has the savings ratio been falling? I think it’s most likely a consequence of wage growth having failed to keep pace with inflation since the second half of 2009. Households are increasing their borrowing, dipping into their savings or simply saving less in order to maintain their standard of living.

The important message is that I don’t think we should get carried away by 0.2-0.3% upward revision to the growth outlook when the overall pace of expansion is still slower what we would consider to be a reasonable recovery for the UK economy. 

We’ve pencilled in a quarterly rate of growth of 0.6% in the third quarter of this year. PMI numbers for the start of this quarter have been very strong. If these PMI numbers are replicated in official output estimates then 2012Q3 GDP growth may be more robust than we currently expect. Overall I think the message to take from recent data releases is that in the very short term the economy is growing at a much faster rate than it was just six months ago. 

The question is can it continue through this year and next? As long as wage growth continues to lag behind inflation, as long as there’s very weak export demand from the Euro Area and as long as businesses are too uncertain about the future to invest it’s going to remain quite challenging. Surveys suggest business optimism is noticeably higher than it was just last year but the CBI Industrial Trends Survey, for example, suggests uncertainty about the demand outlook remains elevated.

Further Reading

Prospects for the UK economy - Simon Kirby

Why real wages are falling - Chris Dillow

Can the UK wean itself off its property price addiction? - Tomas Hirst


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