UK national debt is currently estimated at £1.83 trillion – well beneath the US debt of over $19 trillion. UK debt was less than £0.5 trillion in 2005, but by 2011 it rapidly exceeded £1 trillion. National debt versus GDP in the UK was hovering at 38% in 2005, but by 2016 it hit 80% of GDP. Fortunately, Britons have curbed their expenditures and this trend is flattening out. In the run-up to the UK general elections, Britons reduced their borrowing further, and there were also declines in mortgage approvals.
Consumer credit weakened to its lowest level in 1.5 years in May 2017, as credit card spending was curtailed, hitting retail sales hard. According to the BBA (British Bankers Association), the growth in consumer credit was 5.1% during May, down 1.3% from April 2017. The decline in credit borrowing is part of growing uncertainty in the United Kingdom. Concerns about Brexit negotiations are mounting, after the third round of talks ended in a stalemate recently. Weakness in consumer expenditure has slowed GDP growth in the UK to just 0.3%. Declines in approved mortgages have also been reported, and the month of April had the dubious honour of the lowest mortgage approval rate since September 2016.
Fed and BOE Eschew Rate Hikes for Now
A slowdown in consumer spending is coupled with decreased business investment levels in the UK. Brexit-related concerns remain the #1 reason for the slowdown. Many international companies are heading for other European cities, with concerns mounting about London’s viability as the centre of European commerce and business activity. UK banks and financial institutions are at risk of losing their passporting rights to other cities across Europe, and this is causing mounting uncertainty in the UK.
Reports about the current state of the UK economy vary from stagnant to modest growth. The GBP continues to gain ground against the beleaguered USD, given that US economic data has failed to impress Fed FOMC members. The current probability of a rate hike in the US has dropped to just 2% for the November 1, 2017 meeting of the Fed FOMC. The projection of interest rates remaining at their current level of 1.00% – 1.25%, is now 96.7%. If we extrapolate to December 2017, the Fed will be convening for the last time on Wednesday, December 13, and there is a 36.2% likelihood of a 25-basis point rate hike. This is the highest probability for the remaining Fed meetings in 2017.
Falling Real Wages and Fewer Big Ticket Purchases
The impact of Bank of England or Fed rate hikes on monetary policy has a direct effect on consumer credit. The bank rate in the UK and the federal funds rate in the US serve as barometers of lending rates for credit card companies like Visa, American Express, Discover, MasterCard and others. The higher the federal funds rate, the higher the APR (annual percentage rate) of the credit cards. In the UK, the BOE is targeting an inflation rate of 2% before it pulls the trigger on higher interest rates. In the US, the Fed is looking for signs that the US economy is improving, by way of rising inflation, falling unemployment and strong fundamentals.
If the BOE or the Fed decides to raise interest rates, they risk adding additional pressure to borrowers who are currently indebted on their credit cards, personal loans, auto loans, and mortgages. This is especially true of variable rate mortgages, and credit cards. The housing market is directly influenced by the prevailing interest rate. The higher the federal funds rate or the bank rate, the higher the fixed interest-rate or the adjustable interest rate will go. For now, Britons are holding back on big-ticket purchases, and are concerned more about job stability and staying afloat than indebting themselves with falling real wages and rising prices.