A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK.

In the last 18 months, UK consumers have faced the worst energy crisis in 60 years, double digit inflation and rapid interest rate rises. Last autumn consumer confidence hit the lowest level since data first started to be collected in 1974. No wonder turnover in the housing market has slumped and retail sales are falling.

High inflation has hit spending power, with household disposable income falling 1.3% last year. This is a significant hit by the standards of the last 60 years. Yet along with the headwinds, the UK consumer is also seeing some tailwinds.

High inflation and rising interest rates have so far had surprisingly little impact on the labour market. Unemployment is low, job vacancies are abundant and employment keeps growing. Consumers have been able to dip into savings built up in the pandemic to support spending. Increased borrowing, with consumer credit growth running at the fastest rate in four years, has bolstered consumption. Higher net-worth households have benefitted from a sharp rise in the value of housing and equities since 2019. Meanwhile rising interest rates, up from 0.15% to 4.25% in less than 18 months, have not fully fed through to the majority of mortgage holders with fixed rate deals.

These factors have enabled consumers to keep spending even as real disposable incomes decline. In the final quarter of 2022 household expenditure was 1.6% higher than a year earlier.

Consumers have had to adapt in the face of higher energy and food prices. An Office for National Statistics survey carried out in early April found that 67% of adults were spending less on non-essentials, 55% were using less energy in their home and 42% were spending less on food shopping and essentials. Spending on durables and furnishings has taken much of the strain with sales volumes falling in the last year. The boom in internet sales is over, with sales down about 20% from their 2020 highs.

There is also a compositional question. Official data captures averages or aggregates, which are skewed to higher-income households. In the UK the top 50% of households account for almost 70% of all spending. At the other end of the income spectrum official data shows that 17% of UK households live on less than 60% of median income, the threshold for absolute poverty.

Measuring overall consumer spending does not fully capture the pressure felt by lower-income households because so much spending is accounted for by higher earners. It is also why, at a time of falling real incomes, some parts of discretionary spending remain strong. Demand for airline travel has continued to recover with flights to, from and within the UK up by over 8.0% in the last year. Shares in BA parent IAG, Ryanair and easyJet have risen sharply since last September. Ryanair CEO Michael O’Leary has predicted that an expected increase in airfares this summer of up to 15% will have no impact on bookings.

Overall the consumer is in a marginally better place now than seemed likely six months ago. Consumer confidence is weak, but it has risen from last year’s lows. Inflation should fall sharply over the coming months driven by ebbing pressures from food and energy prices. By the end of this year, inflation, which is currently running at over 10%, is likely to be below 4%.

On average economists expect household spending to contract by 0.4% this year before returning to growth in 2024. Given the scale of the likely contraction in real incomes – on the Office for Budget Responsibility’s forecast it is likely to be the most severe in over 60 years – this would constitute a fairly soft landing for the UK consumer. A forecast of a 0.4% decline in household spending this year compares with a 3.0% fall in the financial crisis in 2009, and a 1.0% fall in the previous recession in 1991. 

A softish landing for the consumer is predicated on several things going right. Inflation needs to fall away quickly to ease the pressure on households and to avoid materially higher interest rates. Any material increase in unemployment would risk a sharper contraction in spending. Consumers will need to keep drawing down on accumulated savings – something that could be forestalled by a renewed rise in economic uncertainty.  Then there’s the question of how mortgage holders cope with the gradual feedthrough of higher interest rates to their monthly mortgage bills. Our back of the envelope calculations suggest that even by the end of this year around a third of mortgages will not have felt the full effect of higher rates. That points to a softening, and spreading out, of the shock from higher interest rates, but it is possible that the peak in rates could be higher or the feedthrough to rates quicker.

That’s a lot of things that need to go right. It’s too early to declare that the consumer is out of the woods.

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