UK wage growth slowed again in June. Since the Brexit referendum, disposable income has failed to keep pace with consumption, forcing households to draw on their savings and borrow more. This is unlikely to be sustained. A rise in the risk of a ‘hard Brexit’ could force households to shrink spending more abruptly.
The Bank of England raised rates at the start of August for the second time since the financial crisis despite ongoing uncertainty over the future relationship with the EU. The central bank believes that wage pressures are building as slack is absorbed. Yet, it is hard to see this in the data. Real income growth remains close to zero. And the pace of household spending has outpaced disposable income since the Brexit referendum, pushing the saving ratio to historical lows and the household financial balance into negative territory. This is highly unusual and is unlikely to be sustained.
The net lending or borrowing of a sector represents the net resources that the sector makes available to the rest of the economy. A positive balance implies the sector has an excess of saving over investment and is building its financial asset position. In the UK, both the public and private sector balances are negative, which means that the UK is a net borrower from the rest of the world and runs a current account deficit.
Regarding important trends, first, corporates tend to act as net borrowers, absorbing household savings to finance investment. Yet, the corporate financial balance has moved closer towards neutral as capex has been weak over the past 18 months. Second, the household financial balance has been on a downward trend since 2009, as the government tightened fiscal policy. The decline accelerated after the referendum and turned negative at the end of 2016. Households have had to borrow, or draw on their reserves, in order to fund their spending and investment activities.
So what does it all mean? First, household borrowing has been rising quite rapidly over the past few years, increasing their vulnerability to higher interest rates. If wages fail to pick up, it is unlikely that households will continue support the economy to the same extent. What’s more, the UK is reliant of the confidence of foreign investors to fund its current account deficit. Concerns about a ‘hard Brexit’ could test “the kindness of strangers”, forcing a more abrupt adjustment in the private sector financial balances.
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