Describing the recovery as ‘extremely fragile’, the Verum Consumer Credit Trends Report for May 2014 has calculated that every 0.5% increase in the Bank of England base rate would result in a ￡4.8bn reduction in household spending. If the base rate increased to 3% it would tip the UK economy back into recession.
Professor James Fitchett, of Leicester University School of Management, says in a foreword to the report:
“The main problem facing the UK economy is therefore now a problem concerning consumer spending and debt. As these data show in considerable detail, the prospect of even slightly higher marginal lending rates could have a catastrophic effect on the economy.”
The Verum report warns that household debt remains unsustainably high due to spiralling mortgage debt. Total household debt increased by 314% from ￡347bn in 1990 to ￡1,437bn in 2013, of which 89% was mortgage debt. House prices increased by 318% over the same period, while household incomes have risen by only 203%.
Robert Macnab, Verum’s director of research, said:
“This elevated level of mortgage debt is unsustainable. In a stable housing market, house prices should grow at the same rate as household incomes so that periodic ‘booms and busts’ are avoided. So unless wages increase quickly, which is unlikely, our analysis of the relationship between household incomes, debt and property prices indicates that UK house prices are currently over-valued by 28%. The average should be nearer to ￡180,000 and not ￡250,000 as it is at present¹.
“This ‘debt spiral’ threat to the economy is compounded by the increased cost of living which, combined with a real terms drop in income, is restricting households’ ability to reduce debt. Following the 1990 recession non-discretionary spending (essentials such as housing, food and fuel) fell steadily, from more than 55% of gross income to less than 50% by 1995. It stayed below 50% until 2004, when interest rates began to increase, topping 55% again in 2008. Since 2009 it has hovered just below the ‘recession risk’ level.
“With household finances under such pressure, any rise in the abnormally low interest rates will have a negative impact on consumer spending. Our research has identified an important threshold when 12% of household disposable income goes to servicing debt interest payments. At this level households cut back significantly on discretionary and often credit-sensitive purchases (such as vehicles, holidays, durable goods and furniture), a scenario which would bring the recovery to a grinding halt. To reach this 12% threshold, base rates would only need to rise to 3%. If mortgage rates followed suit, which they invariably do, the housing market would experience a sharp correction.”
