Few would argue low interest rates have not fuelled the rise in consumer debt – the big question, says Guy Stephens, is whether this is harmful or beneficial to the overall economy
Money is cheap – so is it really a surprise the Bank of England voiced its concerns last week over rising consumer debt levels in the UK? Well, actually it is.
Against 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. It is, however, this loose policy that has allowed people to borrow at ever cheaper rates. This money in turn is spent within our very service-based economy, thus contributing to our positive GDP growth figures.
We can see why the Bank of England initially lowered interest rates, but some would argue it has 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.
Today, the bank holds 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 last Friday with regard to raising interest rates, which led to a rise in sterling and a fall in the FTSE, we believe 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 take a holiday. I do not think any crystal balls will be required today: the base rate will remain at 0.25% – at least for the time being.
It would be foolish to raise interest rates in August while voicing concerns around rising consumer debt. This is because it is bringing forward its annual stress tests on banks, which will scrutinise exposure to consumer credit, 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 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 Bank of England’s average long-term base rate 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 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.
It is worth remembering, however, 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. The area of concern for the Bank of England 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 bank, 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%.
Loan-to-income multiple up
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 above 26%. With Lloyds’ recent acquisition of MBNA credit cards, it is 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 – which 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 Bank of England is trying to establish. Providing 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 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 stockmarkets, there is the argument you are better off taking out a loan than taking it out of the stockmarket 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 it would have been better to keep your money in the market and take out a low interest loan to meet any liability. As always, however, past performance is no indication of future performance …
Guy Stephens is technical investment director at Rowan Dartington