Why household income growth is so important to our sector
Mortgage Strategy
I continue to be surprised at how strong consumer spending and lending has been given the extent of income and employment squeeze on the household sector. In recent years the combination of higher than expected inflation, little or no wage growth and increasing unemployment have shaped our market. We have always seen real income growth of the household (personal) sector as a major driver of household borrowing, consumer spending and indeed house prices.
The chart below shows GDP and household real income growth since the 1949 and including a table showing averaging growth over the period and sub-periods. It is clear that real household income growth has moved broadly in-line with GDP growth but has at a slightly higher rate.
Over the whole period 1949-2012 UK GDP growth has averaged 2.3% compared to 2.6% for real household income growth. If the period is extended back to 1870 UK growth has averaged out at just under 2% and I would expect household income growth would be around this level ( if the data had been collected !). However, if you look at GDP and real household income growth since 2000 this has shown average growth of between 1.5% and 1.7%. much lower than the long term average.
The combination of much slower trend economic and real household income growth has had a profound impact on the medium term outlook for personal lending and consumer spending. This is aptly shown by the large fall in the mortgage debt to income ratio since 2007 and this trend is forecast to continue over the medium term. The slower rate of economic growth and weaker outlook for asset prices generally will significantly limit any upside to the mortgage and credit markets over the foreseeable future. Although these factors are already built into the central forecast it is still interesting to see what the impact of even slower real income growth could be.
The central forecast for gross mortgage lending is shown below alongside two alternative scenarios for nominal income growth in the medium term.
The main forecast shows the mortgage debt to income ratio falling from a peak of 1.33 in 2007 to just under 1.00 by 2020. This forecast could yet prove too optimistic if consumers and lenders choose to deleverage at a faster rate than in the recent past.
The central forecast shows gross lending gradually recovering and reaching £143bn in 2013 and around £168bn by 2019. Scenario 1 assumes that nominal household income eases to 3% per annum in the medium term (around 1% in real terms) or around 1% lower than in the central forecast. This revised outlook for household income would imply gross lending stays at around current levels for the next 3 years before rising to £146bn in 2019. Under this scenario gross lending ends the forecast period 12% lower than under the central forecast.
Scenario 2 assumes we enter a world of little or no real income growth and nominal income growth of around 2%. Under this scenario gross lending dips to £121bn in 2015 before rising to £124bn in 2019. This forecast would be very unpleasant for consumers and the mortgage market but is a distinct possibility if we do not get economic growth back on track.
These very simple scenarios highlight just how exposed we are to relatively minor changes in the outlook for household income and the resulting impact on the mortgage and credit markets. Slightly higher levels of wage inflation and employment could really improve the short run outlook for the market but these look unlikely to be achieved with the current monetary and fiscal policy framework.
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