UK—Weaker Consumption But Still Growing

• Signals from the UK activity indicators have been mixed lately and the combination of high inflationary pressures and falling consumer sentiment are likely to weigh on real consumption growth going forward. That said, consumer spending on services still has some room to grow as there remains a significant shortfall relative to pre-pandemic levels and measures of household savings remain elevated. In addition, while semi-durables and non-durables have reverted to the level consistent with their pre-pandemic trends, there remains upside potential in the durable goods category.
• To assess the outlook for consumption, we estimate a model for the equilibrium saving rate where this equilibrium rate depends on households’ wealth and credit availability. During the pandemic, we find that savings rates were significantly above target, reflecting excess or “forced” savings by households due to lockdown restrictions. We estimate that the stock of excess savings accumulated by households currently stands at around £170 billion (7% of GDP).
• While high inflation will weigh sharply on real incomes, we expect the saving rate to fall below the equilibrium saving rate this year to cushion some of the drag on real consumption. In our baseline, we assume that households will unwind 20% of the stock of excess savings over the next three years, taking the saving rate to 4.8% by the end of this year, and project real consumption to grow by 4.6%yoy in 2022 (vs. 5.2%yoy previously). However, there remains considerable uncertainty around our baseline projection. To gauge this uncertainty, we present a range of additional scenarios. In a scenario where households do not unwind the stock of excess savings, real consumption growth in 2022 is expected to fall to 3.5%yoy, whereas if households were to unwind a larger portion (30%) of this stock, real consumption would grow by 5.2%yoy.
• While we continue to expect the recovery in services spending, fiscal support, and the unwind of excess savings to act as tailwinds to consumption growth (particularly in 2022), on net, we revise down our GDP growth forecasts due to significant headwinds from continued increase in inflationary pressures, higher interest rates, and falling consumer sentiment. We now expect GDP to grow by 3.9% (vs 4.2% previously), 1.2% (vs 1.8% previously), 1.5% (vs 1.8% previously), and 1.4% (vs 1.7% previously) in 2022, 2023, 2024, and 2025, respectively.

In this Analyst, we assess the outlook for consumer spending in the UK and update our GDP projections.

Signs of Weakness But Still Room to Grow

Signals from the UK activity indicators have been mixed lately and there are some signs of consumer weakness setting in. Card spending data continues to demonstrate fairly robust momentum and the services PMI grew further in March to remain above 60. However, mobility data has flattened since late February, measures of consumer confidence have dropped sharply and the year-ahead output expectations measure from the March PMI declined as well (although the latter remains at high levels still). Indeed, the latest monthly GDP data for February slowed more than expected, suggesting the Omicron rebound is largely behind us. Moreover, inflation has continued to surprise sharply to the upside—with an expected peak of 9.5% in October—which will weigh heavily on real incomes.

That said, consumer spending on services still has some room to grow. Exhibit 2 (left) shows that services spending as a fraction of total household consumption fell more during the pandemic, as it tends to be more sensitive to covid restrictions, and has since started to rebound. Importantly, the rotation back into services is only partially complete, and there remains a significant shortfall relative to pre-pandemic levels. In addition, while semi-durables and non-durables have reverted to the level consistent with their pre-pandemic trends, there remains upside potential in the durable goods category (Exhibit 2, right).

Spending and Wages, Related But Not Twinned

While what people earn is an important input into what they can spend, it is not the only relevant factor consumers take into account. Exhibit 3 (left) shows that for the economy as a whole, consumption and wage growth can diverge fairly significantly for extended periods of time. For example, in the period following the financial crisis, consumption growth outpaced earnings growth for several years, with negative real wage growth over 2012-14. Such deviations diminish once other non-wage sources of households’ disposable income are included (Exhibit 3, right).

Another key channel to support spending in the face of a softening in real wage growth is the ability of households to borrow to smooth consumption over time. Exhibit 4 (left) shows that consumer credit tends to be high during periods of soft (or even negative) real wage growth. In addition, current unsecured lending conditions remain fairly loose enabling some households to use borrowing to maintain expenditures during a real income squeeze (Exhibit 4, right). That said, secured credit has tightened sharply recently (light blue line, Exhibit 4).

Consumption Outlook—Taking Stock

By definition, nominal consumption is the difference between disposable income— including both wages and non-wage income—and household savings. Real consumption, in turn, is nominal consumption deflated using consumer prices. In order to project nominal consumption, we map our profile for headline AWE growth into the growth of wages and salaries and assume a gradual recovery in non-wage income over the coming quarter, in line with the pre-pandemic trend.

Turning to savings, we start by estimating a model for the equilibrium saving rate where this equilibrium rate depends on households’ wealth and credit availability. Exhibit 5 (left) shows the estimated equilibrium saving rate from our model fits the data well historically. This equilibrium rate can be seen to have moved up in the period immediately after the financial crisis, as households’ wealth-to-income levels decreased during this period, and fall subsequently. During the pandemic, we find that savings rates were significantly above the equilibrium rate, reflecting excess or “forced” savings by households due to covid lockdown restrictions. We estimate that the stock of excess savings accumulated by households currently stands at around £170 billion, 7% of GDP (Exhibit 5, right).

We have previously noted that we expect the saving rate to potentially fall below pre-pandemic levels this year as households unwind some of the excess savings accumulated during the pandemic. However, estimating the magnitude and speed of the unwind of the stock of excess savings is of critical importance for our consumption growth forecast. In our baseline, we assume that households will unwind 20% of the stock of excess savings over the next three years, with around half of this unwind occurring in 2022 taking the saving rate to 4.8% by the end of the year.

Finally, we map our headline CPI inflation forecast into a forecast for the consumer expenditure deflator and use this, together with the projections for nominal disposable income and the saving rate discussed above, to obtain a forecast for real consumption. All told, we project real consumption to grow by 4.6%yoy in 2022 (vs. 5.2%yoy previously). However, there remains considerable uncertainty around our baseline projection arising from its sensitivity to the unwind of excess savings. To gauge this uncertainty, we present a range of additional scenarios. In a scenario where households do not unwind the stock of excess savings, real consumption growth in 2022 is expected to fall to 3.5%yoy whereas if households were to unwind a larger portion (30%) of this stock, real consumption would grow by 5.2%yoy (Exhibit 6).

Revising Our GDP Forecasts

While we continue to expect the recovery in services spending, fiscal support, and the unwind of excess savings to act as tailwinds to consumption growth (particularly in 2022), on net, we revise down our GDP growth forecasts due to significant headwinds from continued increase in inflationary pressures, higher interest rates, and falling consumer sentiment. We now expect GDP to grow by 3.9% (vs 4.2% previously), 1.2% (vs 1.8% previously), 1.5% (vs 1.8% previously), and 1.4% (vs 1.7% previously) in 2022, 2023, 2024, and 2025, respectively.