Are rising consumer debt levels a concern?
Money is cheap, so is it really a surprise that the Bank of England voiced its concerns last week over rising consumer debt levels in the UK? Well, actually it is a surprise.
Amongst a backdrop of falling wages, low interest rates, rising inflation, rising house prices, the fall of Sterling and quantitative easing – the latter, somewhat ironically, being part of the Bank of England’s current monetary policy to encourage spending- UK consumer debt is at a record high.
We find the Bank of England’s current concern surrounding rising consumer debt levels somewhat contradictory; on the one hand, it is trying to encourage spending, while on the other it is growing concerned about rising debt levels. However, it is this loose policy that has allowed people to borrow at ever cheaper rates. This in turn gets spent within our very service-based economy, thus contributing to our positive GDP growth figures.
We can see why the BOE initially lowered interest rates, but some would argue that they have been too low for too long. As a result, it has backed itself into a corner, with no ammo to combat both rising inflation and rising consumer debts. This Thursday, it will hold its monthly meeting on the current base rate and whether it should raise it, lower it, or keep it the same. Although Mark Carney sounded aggressive on Friday with regard to raising interest rates, which led to a rise in Sterling and a fall in the FTSE, we believe that he was voicing his concerns at keeping interest rates this low, as opposed to advocating an actual change in policy.
Some would say the monetary policy committee would be better off doing what everyone else does in August and go for a summer holiday. I don’t think any crystal balls will be required this Thursday – the base rate will remain at 0.25% – at least for the time being.
It would be foolish to raise interest rates in August when voicing concerns around the rising consumer debt. This is because it is bringing forward its annual stress tests on banks that will scrutinise its exposure to consumer creditably, by two months, to September. Why raise interest rates before knowing the risks of the high levels of consumer debt?
While any future rise in interest rates would be marginal, we cannot see incremental rises above 0.25% each time, so we would argue that the interest rate should not have been lowered after the initial results of Brexit, especially since it was lowered based on opinion, as opposed to any hard economic data at the time.
The average long-term base rate of the Bank of England is around 5%, with variable rate mortgages around 2% higher and personal loans some way above that. While we are a long way away from seeing interest rates this high, it is easy to see the mounting concern that some analysts are having.
There have been murmurings about a collapse in property prices, and any rise in interest rates would certainly send us down a very difficult path. Of course, there are those who would welcome a fall in property prices; after all, many are struggling to make it onto the property ladder.
However, it is worth remembering that mortgages are secured lending from the banks – fail to pay your mortgage and you will lose your home. Consequently rates are far more competitive. I think the area of concern for the BOE is unsecured lending and the impact any rate rise would have on this area of consumer credit. Any increase in interest rates would be proportionally larger in this area than secured lending.
Alex Brazier, the Executive Director for financial stability, strategy and risk at the BOE, expressed his concerns in this area in a speech last Friday at the University of Liverpool. In the past year, outstanding car loans, credit card balance transfers and personal loans have increased by 10%, while household incomes have risen by only 1.5%.
While the banks are fundamentally responsible for lending, it is low interest rates that have undoubtedly fuelled competition in the lending sector. Over the last two years the loan to income multiple has increased from 19% to over 26%. With Lloyd’s recent acquisition of MBNA credit cards, it’s easy to see where the focus of the banks’ lending seems to be.
Since the base rate is so intertwined with the wider economy, it is unlikely we will see any interest rate rises in the near term; therefore, this can only increase consumer debt levels. The crux of the issue though is whether this high level of consumer debt is harmful or beneficial to the wider economy. In short, this is what the BOE is trying to establish. Providing that it is affordable, it will be viewed as healthy, but if it is unaffordable then this could have a detrimental impact on the wider economy as a whole.
There is an automatic assumption that all consumer debt is on the shoulders of those on lower incomes, with very little in savings, but this is not always the case. While there are understandably concerns about rising consumer debt levels, with rising stock markets, there is the argument that you are better off taking out a loan than taking it out of the stock market to meet any liabilities.
This would certainly have been true over the last few years. Since 2010, the FTSE All Share has risen by just over 44%. With many stockbrokers outperforming this benchmark, it is easy to see that it would have been better to keep your money in the market and take out a low interest loan to meet any liability. However, as always, past performance is no indication of future performance.
Guy Stephens, technical investment director at Rowan Dartington