But it does give pause for thought. After all, the MPC itself has previously suggested that an unsustainable build-up in household debt is storing up problems for the future.
We have become used to consumer-led growth in Britain. For the last seven years household consumption has risen at an annual rate averaging 4%, far faster than GDP. It has been sustained throughout by rising real incomes and falling unemployment, at times by one-off factors such as the windfalls produced by building societies’ demutualisation and, more recently, by the strength of the housing market.
The MPC began its most recent rate-cutting cycle in February 2001 in response to developing signs of global recession. The process was given a sense of urgency by the events of September 11. In the course of 2001, the MPC took two percentage points off UK rates, which ended the year at 4%.
Prompt and pre-emptive monetary easing helped Britain to avoid the recession that engulfed the other G7 economies. It also underpinned a boom in the housing market. At its height last autumn, house-price inflation was running at 30% on the HBOS index. This has supported consumer spending indirectly by boosting confidence and directly through the process of mortgage equity withdrawal (MEW).
The MEW phenomenon first appeared in the boom of the late 1980s. At its peak in the summer of 1988, MEW was running at 7.7% of household disposable income. In the recession that followed, MEW collapsed and was negligible for much of the 1990s. It began to re-emerge in the late 1990s, and by the first quarter of this year it was as high as £13.5 billion or 7.3% of post-tax incomes, close to the previous peak, as is shown in the first chart above.
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In terms of the outlook for consumer spending, this year was supposed to be different. For a start, higher taxes in the form of the April rise in National Insurance contributions (Nics) was expected to hit real incomes and hold back private consumption. Public consumption was expected take up the running, and the combination of global recovery and the fall in sterling to more sensible levels — particularly against the euro — opened up the possibility of more balanced growth. The
MPC, fully aware of the imbalances that have emerged in recent years, welcomed the possibility of better balanced growth with exports rising in line with imports.
Second, the housing market had obviously come off the boil and was due for a correction. The only issue seemed to be whether the correction would be benign (falling house-price inflation) or, as was the case in the early 1990s, malign (falling house prices). The MPC put its money on the former, assuming that house prices would stagnate and inflation gradually fall to zero. But there were plenty of economists warning that house prices would fall by 20% (as they had done in the 1990s) and, in one case, urging us to “sell in May and go away”.
For a while it seemed that all of this was falling into place. Data for the first quarter of the year revealed the expected slowdown in consumer demand. Retail sales were flat and household consumption in aggregate rose only 0.2%, its slowest quarterly rate of expansion since 1997.
The second quarter opened in similar vein. Retail sales were subdued in April and May and analysts pointed at the hit to household budgets from the increase in Nics. The looked-for correction in the housing market was also evident, as house price inflation subsided rapidly from the heady rates at the end of 2002.
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What was still missing was any real evidence of global recovery. The conditions are in place but, as the MPC observed at the start of last month, the recovery itself is hesitant. Forecasts for America and, more especially, the euro area were being revised down. Even with the fall in the pound, the outlook for British exports is difficult.
That, then, was the background to the July meeting of the MPC. In cutting rates to a new 48-year low of 3.5%, the MPC cited not just the weaker than expected global background but also “slower consumer demand”, sub-trend output growth, subdued wage inflation and the partial recovery in sterling.
The MPC’s July minutes revealed that it split into three camps. For one group the case for a cut was clear; for Rachel Lomax, the new deputy governor, it was far from clear; for the middle group, which had swit- ched from a no-change vote in June, the decision was “finely balanced”.
A particular cause of concern for some members was that the rate of growth of secured and unsecured borrowing by households was still unsustainably high, and might be exacerbated by a rate reduction.
A month later and in the light of the most recent data, the concerns of “some members” are even more apposite. It may be reading too much into one month’s data, but the figures for retail sales and borrowing suggest that reports of the death of the British consumer were exaggerated. All it took for us to resume spending was for the sun to come out or a new Harry Potter to hit the shelves.
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The squeeze on household budgets is real. Headline earnings growth is running at a modest 3%-3.5%. This means that — measured net of the tax and price index (which captures the rise in Nics) — the growth in real earnings has turned negative. There is a huge gap between falling real earnings and the 6% rise in retail sales volumes in the year to June, as is shown in the second chart.
This is where MEW comes in. Earlier in the quarter we appeared to be adjusting our spending in line with the hit to real incomes. Now we have raised our borrowing to maintain our spending power.
Record levels of consumer credit (£2.2 billion in June) and mortgage borrowing (£7.8 billion), much of which is used to finance regular spending through MEW, bear testimony to the resilience of the consumer and our willingness to maintain our spending in the face of higher taxes.
Financial markets have concluded that the MPC is most unlikely to cut rates again in August. They have not completely given up on the possibility of one more cut later in the year. But in the face of the unexpected strength of spending and borrowing in June, the case for further monetary easing is increasingly marginal. It is an open question whether the finely balanced decision in July would have gone the other way if the June data were to hand. My guess is that, if the MPC had known how strong spending and borrowing were, then rates would still be at 3.75%.