Building Societies Association
Factors affecting household savings
From the mid 1990s up until 2008 the UK household saving ratio (which measures the proportion of income saved, net of borrowing, as a percentage of total disposable income) was in decline. During this period long term interest rates were falling, unemployment rates were low, asset prices were rising, and markets were awash with cheap credit. All of these conditions provided an incentive for households to spend and borrow rather than save. And in 2008 the savings ratio reached minus 0.8% which means households were net borrowers. The last time this occurred was in the 1950s.
The savings ratio has now begun to rise again as borrowing has fallen and saving has increased, and at the end of Q2 2009 the ratio was back at 5.6%. The economic environment has changed dramatically since 2007, and these changes will partly determine the future of household savings, as investigated recently by the Bank of England[1] .
Credit conditions
One of the most immediate, and direct effects of the recent financial turbulence has been the much tighter credit conditions imposed by financial institutions on households. The chart to the right shows that availability of credit has reduced consistently from Q2 2007 until Q1 2009. Not only has the supply of credit greatly reduced, but the cost of borrowing has increased as firms re-price risk and repair balance sheets. As a result, households are less able to spend which leads to a rise in the savings ratio.
The Bank of England has pursued an aggressive monetary stimulus policy in order to boost the flow of credit. The chart shows that in Q2 2009 the availability of secured credit over the previous three months increased for the first time in two years, and whilst conditions may ease somewhat, households will still find securing a loan considerably more difficult and expensive compared to pre 2007. This should contribute towards increased levels of net savings in coming months.
Unemployment
After several years of economic growth and low levels of unemployment, job uncertainty increased during the recession and may rise in coming months as the number of job losses rises further. The uncertainty over future income may lead to consumers saving more and borrowing less in order to build up a precautionary buffer to protect against an unexpected fall in income in the future.
Asset prices and Wealth
Asset prices have fallen sharply over the past two years which reduced household wealth and, despite some recovery in recent months, households would need to save 10% of their income for nine years to bring wealth back from its Q1 2009 level to the average over the past 20 years (Bank of England Quarterly Bulletin Q3 2009). This suggests that consumers may increase their savings in order to compensate for falling asset prices, and help restore their wealth. Taking a broader view it is argued[2] that changes to house prices do not have a profound effect on wealth, as for every person suffering from falling house prices, there is someone benefiting from more affordable housing. But falling prices can have other effects on the economy which will impact upon the savings ratio. Price reductions reduce the collateral against which owners can borrow which makes it more difficult to secure credit. Given the current economic climate, house prices are unlikely to make substantial gains in coming months which should support a rise in the savings ratio.
Monetary and Government policy
Over the past year the Bank of England has embarked on a significant monetary stimulus to encourage lending in the economy. The Bank rate has reduced dramatically, and is now anchored at 0.5%, where it has been for the past six months. Interest rates are a direct influence on the level of household savings, and these low rates discourage saving. Furthermore, the Bank’s programme of quantitative easing is leading to inflated asset prices which will increase households’ wealth. These policies combined will encourage consumers to spend more and save less. Interest rates are expected to remain at these low levels well in to 2010, and so we can expect monetary policy to act as a force reducing levels of gross savings and hence the savings ratio.
There is also an expectation for taxes to rise in the future as a result of the UK’s substantial national debt. Forward looking consumers would therefore be expected to increase savings over the coming months in order to maintain consumption levels when taxes rise.
Conclusions
There are many factors that influence household spending, and it is difficult to measure the magnitude and duration of each influence. Given the above analysis it would appear that most households will be incentivised to increase their levels of gross savings in coming months, but faced with a tough economic climate, it is likely many will not have the capacity to save as much as they might like. With loans more difficult to secure, and credit conditions likely to remain tight the savings ratio is likely to stay positive, and perhaps start trending back towards its long term average.
-
This article is based on the report “Household Saving” by Start Berry and Richard Williams, in the Bank of England’s Quarterly Bulletin Q3 2009 edition.
Dale, Spencer (24/09/09) Separating fact from fiction: Household Balance Sheets and the Economic Outlook
