Week 31, 2017: Household Debt v.s. Interest Rates and CPI

   

Summary:      The base rate climbed steadily to 5.5% in 2008 before the global financial crash, after which it plummeted to 1.5% within one year as the Bank attempted to stimulate investment and consumption. This represented the single fastest and largest fall in the base rate since 1977 when the interest rate fell 7.5% in one year.    

With the exception of the 2009 and 2010 following the global financial crash, the total level of average household debt has risen year on year. In the period shown total household debt rose 236%, from £774 billion to £1825 billion (although the population and number of households has also increased in this period). CPI began to fall sharply in 2011 as a result of post-crisis reduction in consumer spending and, driven by the maintenance of very low interest rates, total household debt has continued to rise.   

What does the chart show?     This chart shows the relationship between the average household debt, inflation and the base rate between 2000 to 2017. CPI is shown by the blue line on the graph and the orange line represents the interest rate set by the Bank of England, with both plotted against the right-hand axis. The grey bars, measured against the left-hand axis, represent total UK household debt in billions. 

Why is the chart interesting? One could attempt to infer that the rise in household debt reflects changing consumer attitudes towards borrowing, perhaps indicating that increasingly people find borrowing and spending beyond their means acceptable. However, when combined with the fact that 9.45 million UK citizens live without any savings, the rise in debt is far more likely attributable to the sustained low base rate.

Although CPI fell between 2011 and 2015, this was largely due to the decline in oil price. Household income and wages have stagnated prior to the crash and therefor the rise in debt cannot be simply attributable to UK households spending beyond their means. In the longer term, it is likely that inflation will continue to rise as a result of the Brexit referendum and a corresponding rate rise will be likely.

10 years on from the financial crisis, the Bank of England has sounded repeated warnings about the state of consumer debt in the UK and recently accused financial institutions of ‘forgetting the lessons’ of the crash and ignoring mounting levels of risk. Credit card lending in particular has skyrocketed in recent years to £68.5bn and lenders are so optimistic of the nation’s economic prospects that they are reducing the capital put aside to finance defaults. This is despite 248 people per day being declared insolvent or bankrupt.

In 2015, the UK’s household debt-to-income ratio was among the highest in the EU, exceeded only by Sweden, Norway, Denmark and the Netherlands. The UK gross debt-to-income ratio of households was 123.97% and the Eurozone average was 93.85%. In March the OBR’s forecast that by 2022 UK household debt could reach £2.322tn.