Time to put away the credit card

Published on Housing, Wealth and Debt

The squeeze is on. National accounts data last month confirmed that household incomes have been falling for the last three quarters. Yesterday’s labour market statistics showed that wages continue to lose ground to inflation. And today new survey data from the Bank the England shows that credit availability is tightening.

Today’s survey is the latest sign that the use of debt to prop up living standards – the ratio of consumer debt to income is currently 40 per cent, its highest level since the crisis – is on borrowed time. This is good news for financial stability but, as is it likely to dampen consumption, is bad news for short-term economic growth.

Banks are becoming less willing to lend

As the chart below shows, banks have been tightening their credit scoring criteria for the last three quarters, making it tougher to get unsecured loans or credit cards. This is a turnaround from six years of post-credit crunch loosening, and banks expect it will continue into the third quarter of 2017.

It’s easy to assume that banks are simply reacting to over-indebted customers, cutting them off before things get messy. But the bars in the chart (based on a different survey question) tell a more nuanced story. The credit tightening was actually initiated by a weaker economic outlook following the EU referendum. Only now, in the most recent quarter, are banks worried about risky customers. Looking ahead, lenders think both factors will continue to drag on their ability to offer credit.

Lenders are signalling that there may be a more hostile borrowing environment in the future. If credit markets tighten at the same time as incomes are falling, that would mark a major break from recent consumption-fuelled growth.

A responsive credit market is good, but it comes at a cost

Alongside the spike in consumer debt, the household saving ratio has fallen to its lowest level ever (the data goes back to 1963).  ONS revisions in September may flatten this drop somewhat. But the overall picture remains the same.

Of course, the use of debt to smooth consumption is a normal response to a slump. But it has the potential to cause problems if families become too reliant. We may well be reaching this point.

The credit conditions survey also asked about consumer behaviours such as default rates; an early warning sign of unsustainable borrowing. Apart from a blip at the beginning of 2017, this indicator has been rising for the last 18 months as households turn to debt to sustain their living standards. This rising incidence of sour loans would feed into the lender’s falling risk appetite described above.

Given recent history, the apparent restraint being shown by lenders is reassuring; pulling back before systemic problems arise. This is a sign that lessons from the past have been learned: you can’t run an economy on debt forever.

However a mature, responsive credit market has its price. It means we must confront the economic reality sooner. Consumer debt has papered over a long-term structural problem: credit isn’t just supporting living standards; it’s been supporting the whole economy.

Private consumption accounted for the entirety of economic growth in 2016. Without household spending growth, we would be looking back at a shrinking economy. If banks do restrict access to credit, we can expect this to put downward pressure on spending, leading to lower economic growth.

There is no easy option

This leaves us with a dilemma: keep borrowing to maintain living standards (and prop up GDP); or reduce consumer borrowing to maintain stability. The first option just kicks the can down the road. In any event, lenders seem to be making the decision for us by tightening access to consumer credit. We’re learning again that debt is no substitute for decent wage and wider income growth – something that’s been in short supply over the last decade.

Subdued household spending will have implications for the rest of economy. Another sector, such as business investment or trade, could pick up the slack; but we’ve seen little evidence of any rebalancing in recent years. Even if other sectors do step up, the economic outlook for 2017 remains modest at best.

With this in mind, it is important that we reflect not just on growth levels, but also on how any gains are shared.

The Resolution Foundation will shortly be publishing our annual audit of living standards, highlighting how different parts of society have been faring over recent years. As the squeeze takes hold, some will be gripped harder than others.