Here is some good news about a possible recovery in the UK. No, no, really. Take your cynical hat off, there are no catches. There are reasons to think the UK may recover a tad sooner than originally expected. It depends, of course. It could go wrong, but there is reason for a healthy dollop of hope. And this is why.
The latest consumer confidence index produced by GfK NOP on behalf of the EU commission improved. Okay, it wasn’t much of an improvement, up from minus 37 in January to minus 35 this month. That’s still 18 points down on this time last year, but let’s be grateful for small mercies.
You have to be careful with statistics. There is a lot of randomness out there. Just because we had a cold winter this year, it doesn’t mean there is evidence of climate change. It neither proves nor disproves the climate change hypothesis. And in the same way, one month’s set of slightly better data may mean nothing.
Put the improvement in consumer confidence together with recent news that the High Street enjoyed something of a pick up in January, however, and maybe evidence of a recovery is mounting. But then again, that could be a coincidence too. If you toss a coin in the air twice in a row and get heads each time, it does not mean the coin is weighted.
But now put the data to one side, and instead apply common sense.
At last, there is mounting evidence that rate cuts are being passed on to mortgage holders. This trend will continue. Next year, even those on two-year fixed rate deals agreed when rates were at peak, will start to benefit.
This means for some, the cost of repaying a mortgage is falling away. Add that to cheaper petrol, cheaper utility bills that are sure to follow, modest rises in council tax, and cheaper food, there’s reason for us to feel better off.
Okay, those of us who regularly take one or two holidays abroad will be feeling the pinch, but then again, there’s always Margate.
For those of us who can keep our jobs this year, there are reasons to assume we will be better off. So, what does this mean?
It boils down to whether we use the improvement in disposable income to pay off debt, or spend. If we do the sensible, prudent thing, and reduce debt, the UK economy will contract, job losses will mount, wage inflation may go negative, and we will start to lose the benefit of cheaper prices.
Then again, the UK’s consumer is in too much debt. Until this is reduced, the underlying problem with the UK can not be fixed. So the ideal scenario is to see some of the improvement in disposable income used to reduce debt, and some used to spend.
Because the pound has fallen so precipitously, employers in export sectors should be able to avoid the worst of the recession. Those employers who rely on internal demand, should benefit from the improvements in affordability.
The Bank of England has predicted a sharp pick up for the UK next year; by the scenario described above, it may be right.
Furthermore, the sooner banks start passing lower interest rates on to borrowers, the less likely it is their borrowers will default, and the lower bad debts will be.
What can go wrong? Well, actually, there are three snags.
If inflation comes along again, as some expect, interest rates will need to go back up. Or maybe the UK government will find it can’t borrow the money it needs without upping rates. Alternatively, if sterling continues to fall, rates may need to be raised.
The second danger is the precise opposite of the first – so dangers one and two are mutually exclusive of each other. And this second danger is deflation. If wages start to fall, then a nasty downward spiral may result.
But the third and key factor is house prices.
Will consumers find the fall in the value of their home makes them feel so much worse off that they will cut back on spending, even though falling prices mean disposable income improves?
It seems that there are two issues here. Many British consumers have got so used to seeing their home rise in value, that they have been funding their spending out of equity – or at the very minimum they cut back on savings because they felt it wasn’t necessary.
In the environment of falling house prices, it seems inevitable savings rates will rise, meaning consumer spending will fall and job losses will mount, and wage inflation may go negative.
Then there’s those on negative equity. If your mortgage is worth more than your home, then that really is dreadful news. You can’t move, you can’t take a job in another area, and you may give up hope.
The obvious solution then is to get house prices up again. But that can only ever be a temporary fix. House prices are still too high, and the longer the correction is delayed the worse it will be.
Surely the real fix lies in introducing some kind of government-backed negative equity mortgage. A mortgage that has at least some portion treated in much the same way as a student loan, with payments deducted directly from income.
Recently, Gordon Brown revealed his idea to ban 100 per cent mortgages.
Well, actually, that is the last thing those with negative equity need. Unless they can access mortgages of, say, 120 per cent or more, then the economy will be stifled, and may remain in the mire for years.
PS. This article is a touch parochial. World-wide, the problems are more serious, and this could rebound on Britain.
© Investment & Business News 2013