Popular mythology is that the recent economic pick-up has been consumer-driven and reflects an unwelcome return to debt-financed spending. This is wrong.
Consumer spending accounted for only 0.4 percentage points (pp) of the 1.0% rise in GDP between the fourth quarter of 2012 and the second quarter of 2013, according to current official data. Net exports were a much bigger positive, adding 0.9 pp, while fixed investment contributed 0.25 pp. The GDP rise was limited to 1.0% because increased demand was met partly from inventories – positive for second-half production prospects.
Total household financial debt has fallen from a peak of 170% of disposable income in the first quarter of 2008 to 144% in the first quarter of 2013 – see first chart. It is true that the debt to income ratio rose between the fourth and first quarters but this reflected a temporary drop in income due to a shifting of bonus payments from 2012-13 to 2013-14 to take advantage of the cut in the top income tax rate. The first quarter increase, in other words, probably reversed last quarter.
The debt to income ratio is likely to decline further during the second half. Borrowing from banks – which accounts for three-quarters of the stock of debt – rose at an annualised rate of only 0.9% in the three months to July. Average weekly regular earnings and employment increased by 2.7% and 0.9% annualised respectively in the latest three months, consistent with income expansion of about 4%.
Credit demand is picking up but leading indicators such as mortgage approvals do not currently suggest that debt growth will rise above 4-5%. The debt to income ratio, in other words, may stabilise in early 2014 but a rise is not yet being signalled.
A judgement about whether debt is supportable must take account of servicing costs and the value of tangible and financial wealth. Interest payments were only 5.6% of income in the first quarter of 2013, a new low in data extending back to 1987 – first chart. The interest burden would remain below its post-1987 average of 8.7% even if the average interest rate on debt rose by 2 percentage points.
The ratio of debt to wealth, meanwhile, is likely to fall below its post-1987 average of 17.4% in 2013, taking into account house and share price rises through mid-year – second chart. It is commonly argued that both are significantly overvalued but this is not supported by income yield analysis – the dividend yield on equities and the rental yield on housing* are not low by historical standards.
Concern that stronger growth has been achieved via a deterioration in consumer finances may partly reflect a sharp fall in the saving ratio in the first quarter but – like the rise in the debt to income ratio discussed above – this was due to bonus shifting into the second quarter. The ratio, in other words, is likely to have returned to around its fourth-quarter level of 5.9% in the second quarter. The latter is close to a post-1987 average of 6.1% – third chart.
*See previous post.
