Alarm bells are jangling at the Bank of England. Households have been on a borrowing binge. Consumer spending is being underpinned by debt, with an increased dependency on personal loans, payday loans, car finance and – in particular – credit cards.
Threadneedle Street is worried about these trends – and rightly so. Household debt as a proportion of national income peaked at 160% at the time of the financial crisis and fell only modestly thereafter. Now – having bottomed out at 140% of GDP – the ratio is on the rise again.
The Bank’s financial policy committee wants to know whether the increase marks a return to the bad old days when lenders put themselves in jeopardy by making it far too easy to obtain credit. A report into credit quality being conducted by the Prudential Regulation Authority will be the trigger for action if it finds that competition for business has led to a dilution in credit quality.
It seems improbable that the PRA will come to any other conclusion. As the Bank said in its February inflation report, consumer credit growth exceeded 10% in the year to December 2016. Lenders have slashed the cost of borrowing: the interest rate on a £10,000 unsecured loan has fallen from 10% in 2009 to below 4% currently. There has also been a marked lengthening in interest-free periods available for those who transfer their credit card balances.
Some loosening of credit conditions has been justified. Unemployment is low and the past couple of years have seen chunky increases in real disposable income. Lenders are in better financial shape than they were during the financial crisis and many households have used a prolonged period of ultra-low interest rates to improve the state of their finances.
That said, the growth in credit is too strong for comfort and if lenders do not of their own accord start making debt harder to come by, the Bank should force them to do so. Why? Because all the ingredients – bar one – are now in place for a traditional UK credit boom-bust. The economy is slowing, real incomes have started to fall, the housing market has run out of steam and unemployment is projected to start rising.
Britain has been here before, many times. The current cycle began halfway through the last parliament, when the government provided incentives to lend and encouraged mortgage demand on the grounds that debt-driven growth was better than no growth. Five years later, the only thing lacking is a tightening of interest-rate policy from the Bank. It would take only a modest increase in interest rates to cause serious distress.