The threat posed by debt just won’t die down. Last week we reported that the Bank of England’s figures suggest that the UK cannot afford much higher interest rates. New figures from the Resolution Foundation suggest that the situation is even worse than the Bank of England suggested.
“If interest rates rise 1 per cent,” said the Bank of England in its latest Financial Stability Report, “households accounting for 9 per cent of mortgage debt would need to take some kind of action — such as cut essential spending, earn more income (for example, by working longer hours), or change mortgage — in order to afford their debt payments if interest rates rise…If interest rates rise by 2 per cent," continued the Bank, “ditto, except that that it will be households accounting for 20 per cent of mortgage debt who will be so cursed.”
The Resolution Foundation has also taken a look at the story of the UK’s household debt, and its conclusions are even more disturbing.
Before the crisis of 2008 household debt across much of the developed world was worryingly high. Some countries, such as Denmark, Ireland, the Netherlands and Norway had it worse. Nonetheless with a ratio of household debt to gross house disposable income of 174, it was worryingly high in the UK. The good news is that it has since fallen, and the ratio at the end of 2012 was 146.
Alas, according to estimates from the Office of Budget Responsibility (OBR) it is set to rise again – not by much, for sure, but any rise is worrying. The OBR does in fact project that there will be a household debt to disposable income ratio of 151 by 2017 . To put that in context the ratio was just 112 in the year 2000. In the US, at the end of 2012 the ratio was 106.
According to the Resolution Foundation, at the end of 2012 no less than 3.6 million households were spending more than a quarter of their disposable income on debt repayments. Debt levels, however, are expected to rise as the government attempts to kick life into the UK housing market by encouraging greater mortgage lending.
But in its most recent report the Resolution Foundation looked at households whose debt repayments make up more than half of disposable income, or those in so-called debt peril. Right now, around 2 per cent of all households are in this position. If things carry on the way they are supposed to, and rates rise in line with Bank of England projections and real wages increase in line with projections for GDP, the Resolution Foundation estimates that the percentage number of households in debt peril will rise to just under 3 per cent by 2017. This is similar to the level seen in 2007, in fact.
If rates rise by 2 percentage points more than expected, the foundation estimates that the percentage number of households in debt peril will rise to 4 per cent. If, in addition to this, wages fail to rise with GDP, but rather – as has been the case in recent years – increases in wages continue to be outstripped by inflation the Foundation estimates that the number of households in debt peril will rise to 5 per cent.
Okay, you might say, but if this is the case then the Bank of England may not let interest rates rise. Unfortunately, central banks may have less say over the matter than is generally thought. See: The Great Reset
There are all sorts of combinations and permutations. But the points to remember are these:
As rates rise in the US, the Bank of England may be forced to either up rates, or let the pound fall. If rates rise, debt levels in the UK will increase. If the pound falls, inflation will pick up, real wages may fall, and once again debt to income may fall.
In short, we may be in big trouble whatever happens.
But just bear this in mind. Debt does not matter if the percentage interest on debt is less than the percentage increase in income. What the UK really needs is for incomes to rise, and for this to happen it needs improving productivity, which comes from more investment.
© Investment & Business News 2013