Where’s UK economic growth going to come from?
0We’re often asked by trustees as to where economic growth will come from, and there’s a general prejudice that household consumption, which has been one of the main drivers of weakness in the UK economy over the past five years, contributing just under 2% of the 3% decline in real GDP between Q1 2008 and Q4 2012 will continue weak.
The weakness in recent years is unsurprising, with the household sector hit by a rise in unemployment and declines in real income growth. In addition, the household saving ratio rose from under 2% in 2007 to above 7% in 2012, leading to a decline in consumption. In part, this may reflect a precautionary savings motive, as well as a desire to de-leverage.
Nonetheless, we believe that the prospects for household consumption are improving, and we could start to see a meaningful contribution to growth from this sector over the next few years, supported by rising employment growth, eventual wage inflation from looser monetary policy and increased labour demand, Funding for Lending Scheme leading to a reduction in mortgage rates, limited fiscal tightening in 2013-14 and rising asset prices, particularly in equity and housing markets
In terms of the details of these factors, over the past year, the employment growth rate has risen dramatically, reaching the highest annual growth rate since the end of the 1980s. That said, the labour market is not all positive news, with some tentative evidence that unemployment rates have stopped declining and have actually increased marginally in the past few months. In addition, actual wage inflation remains low, but increased employment growth could begin to put upward pressure on inflation in the medium term.
In conjunction with higher labour demand, loose monetary policy should aid wage inflation, with a decent chance that Mark Carney as new governor of the Bank of England seeks to stimulate domestic price pressures, leading to increases in nominal wages. While there may not be a shift up in real wages, improvements in nominal wages could help households to de-leverage and this could reduce savings ratios, and increase consumption spending.
The Funding for Lending Scheme could, at the margin, be positive for households by reducing net interest payments. Assuming that outstanding mortgages are worth around £1250bn, and gross disposable income is around £1050bn, a 50bps reduction in average mortgage rates equates to around 0.6% of gross disposable income. However, households also hold a substantial amount of bank deposits, and the impact of the Funding for Lending Scheme has partly manifest itself by allowing banks to reduce what they pay on these deposits. What this means is that the distributional impact of these changes in rates is important and those who hold substantial deposits may not be the same individuals who have significant debts. Thus lower deposit rates could stimulate certain households into spending rather than saving, and at the same time, lower mortgage rates could help households who have a significant amount of outstanding debt. On balance, the impact of this could be lower savings ratios and an increase in consumption.
Finally, there could be support from fiscal policy in the short term, as well as from the recent rises in asset prices. On this latter point, UK equity prices have risen markedly in the past six months but house price growth has remained relatively subdued, albeit prices are still only 5% below peak levels. Importantly, recent measures by the government such as the Help to Buy scheme could help to push up prices and even if the net impact of these measures is simply to increase transaction volumes, this could improve household confidence by increasing the liquidity of the most sizeable asset.
We will be monitoring these factors on an ongoing basis – but certainly see grounds for considered optimism.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
