How Much Trouble Is the UK Consumer In?

Summary

• I have been dovish on the Bank of England (BoE) for a long time. Since last December, my base case has been for a pause at 4%. This remains in play unless next week’s data or Spring Budget provides a hawkish surprise.
• The pressure on the consumer is one of the main reasons for the UK’s dour outlook. They are less supported by fiscal policy than in the US and EZ, have been less insulated from energy prices, and will be sooner affected by higher rates.
• We continue to find that UK household savings will be increasingly under pressure ahead into 2023. This should provide the BoE more room for dovishness.

Market Implications

• We see value fading BoE hawkish pricing. If the Monetary Policy Committee (MPC) do indeed pause, then there should be room for further GBP weakness ahead.

I have been dovish on the BoE for some time. My position since December has been that they will choose to pause hiking at 4%. Such an outturn is greatly dependent on imminent outturns, including next week’s labour market data (14 March) and Spring Budget (15 March), and inflation data (22 March) the week after, but it remains my base-case.

Why Are We Less Hawkish on the BoE Versus the ECB or Fed?

For one part, after recent misses, the trajectory of UK core inflation is far less concerning than in the EZ or US (Chart 1). It is a similar story in services. More importantly for medium term, the UK’s economic outlook is far gloomier on account of pressure on consumers. There are a number of reasons why this has been more acutely felt than in the US and EZ:

1. The UK is facing greater relative fiscal policy tightening than the EZ or US.  This is particularly noticeable in the expected change in deficit spend from 2022 to 2023 (Chart 2).
2. The BoE began monetary tightening before the Fed or ECB. This and shorter typical UK mortgage fix periods (almost all <5Y) mean consumers feels it sooner[1].
3. UK consumers have been less insulated from price rises – particularly in energy and electricity. There, the pricing mechanism has played a strong role (Chart 3).
4. Total UK worker compensation has been suppressed by negative real wage growth and low employment levels. The EZ has suffered worse real wage declines, but the rise in employment has at least provided an offset (Chart 4).

Last summer we published on the pressures facing UK consumers. Our analysis then was based on annual data for a household of one with a mortgage equal to the average new mortgage size. This, and the fact that at that time energy prices were not being offset by the government meant for a particularly negative outlook. We now make this analysis more timely using monthly data, and shift towards average mortgage size (based on stock of mortgages rather than new ones) to better represent the average UK household.

We find our analysis provides a relatively good timely approximator for savings rates (Chart 5). Using BoE assumptions for changes in unemployment, wage growth and inflation, the outlook suggests continued deterioration in UK consumer strength.

Important note: our estimator is not all encompassing. It is based on an average (mean) household, and hence benefits from comparatively small mortgage exposure it also avoids the significant increases in cost that renters have seen recently. As such, it predicts a consistently higher savings rate than the ONS provides. The trend rather than the level is hence likely more insightful.

Looking at the nominal figures, by the end of 2023, our representative household is able to save 15% less per month than they were at the end of 2022. This figure will highly depend on consumer behaviour (I assume no change is made to retail spend habits, and inflation is simply absorbed by the consumer). More likely, spending will be cut to provide a better buffer, which will eat into GDP as well as company capacity to raise prices. Similarly, a suppression in savings is likely to drive increased consumer borrowing (something we warned of last year), which will put further strains on household balance sheets (Chart 7).

Unfortunately, the above example is hardly representative of the population. Instead, there will doubtless be a great disparity in consumer pain, with those most vulnerable (the poorest, youngest and most in debt) suffering worst. As these are (by definition) the groups with the highest marginal spending, this could mean the ultimate impact on total consumer spending is magnified.

Market Implications

I continue to see market pricing for BoE hiking (currently pricing another 100bp of hikes) as too high. As such, I see value fading the move there. Sterling weakness has been a popular topic in the financial press, but market positioning for GBP is relatively neutral (at least as of early February when CFTC last updated their numbers). As such, there may not be too much risk of the trade being overcrowded (Chart 8). If the BoE does pause at their March meeting there should be room for further GBP weakness.

[1] c.3Y average in UK; c.50% of new EZ mortgages were fixed >10Y in 2019 (vast majority 15-20Y in France; most 10Y or more in Germany; generally full term for Italy although c. 30% variable; c.30% variable rest mostly >5Y in Spain), 15 or 30Y typical fix in the US.

Henry Occleston is a Strategist, who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)