Confidence trick?

In our latest Household Finance Review we examine the patterns of consumer borrowing and spending in Q2 2022 as cost-of-living pressures increased.

Download the Q2 Household Finance Review here

Rising inflation, most notably from energy price rises in April, plus the increased National Insurance contributions which kicked in at the same time, have borne down on real disposable incomes, and expectations of further pressures to come have driven consumer confidence to record lows. Despite this, however, spending remained strong and mortgage borrowing, while lower than the Stamp Duty holiday-fuelled numbers seen last year, looks to have returned to pre-Covid-19 activity levels. Although at face value this appears counterintuitive, the answer behind these puzzling numbers may in fact be this very weakness in consumer sentiment.

Households are downbeat, not only about the outlook for the economy but also about that of their own finances. Normally, we would expect this to translate to a drop-off in demand.  However, for well over a decade, “normal” has been against a backdrop of low inflation and low interest rates. This has meant that, so long as your income remains intact, what you could afford today, you could likely afford tomorrow.

Now, as inflation hits double digits for the first time in a generation - with more expected over the coming months - and little prospect of most employees securing matching pay awards, that paradigm has shifted. Wrapped up in the low consumer confidence figures is the real possibility that what you can afford today, you may well not be able to afford next year. Therefore, buying a new washing machine, or the family holiday which Covid-19 has prevented for two years now, may reflect rational behaviour for households who are increasingly aware that rising inflation may well push these items out of reach in the near future.

Similarly, the current return to pre-Covid-19 trends in borrowing for house purchase, with no apparent further drop off in demand in response to cost-of-living pressures and resulting weak confidence, may also contain an element of accelerated buying decisions, with the potential that rising interest rates and non-mortgage expenditure will constrain affordability in the not-too-distant future.

Chart 1: Card spending in month

HFR-Q2-chart1

Source: UK Finance​​​​​​

For existing mortgage holders, there are a different set of considerations, although these too are linked to the escalating cost of living. Our analysis indicates that, for borrowers coming to the end of their fixed rate deals and looking to refinance this year, the combined impacts of cost-of-living and interest rate rises since they took out their last mortgage would reduce their “wiggle room” – the free disposable income left over after subtracting tax, mortgage costs and basic household expenditure – by around 11 percentage points as at the mid-point of this year.

This represents a significant reduction in households’ finances but would still leave the average mortgaged household with around a quarter of their income left over accounting for all cost increases.  However, at the margins, and particularly amongst lower income mortgaged households, free income will be significantly more constrained and some are likely to have little or no wiggle room without making adjustments to their expenditure.

Chart 2: Number of loans for house purchase, 2019 to 2022

HFR-Q2-chart2

Source: UK Finance

Again, consumer sentiment as to greater cost pressures in the future is likely to support the already-strong remortgage numbers this year. There is greater incentive for those coming off fixed rates, as well as those who may have been on relatively favourable historic Standard Variable Rates for some time, to refinance now while the cost of doing so is lower than it is likely to be in the near future.

Overall, household spending and borrowing appears to be holding up well for now, even when we might have expected it to start to soften. While a drop-off in activity levels is inevitable as pressures become more pervasive it is likely that, perversely, a negative outlook is the driver of current strength. Consumers making purchase decisions and putting their finances in order now, ahead of tougher times ahead.