UK consumer credit (excluding mortgage borrowing) rose by £1.9 billion in March 2016, compared to the average of £1.4 billion over the previous six months. The year-on-year (YoY) growth was 9.7%, the highest rate in more than 12 years and faster than the pace in the run up to the Great Financial Crisis.
For households, an improving economic outlook, strength in the labour market and low interest rates have contributed to a surge in demand for personal loans, greater borrowing on cards and rising bank overdrafts. For banks, the abundance of liquidity, better household finances and competitive forces have led to a growing appetite to lend.
Strong consumer credit growth has helped boost household consumption. In terms of aggregate demand, this has more than offset recent weakness in fixed investment and net trade. According to the Bank of England’s (BoE) Credit Conditions Survey in March, lenders expect credit availability to households to continue to improve during the second quarter.
While strong credit growth is beneficial to economic activity, we are concerned that the current pace is unsustainable. Consumer credit is currently expanding at more than four times the pace of regular average earnings growth (2.2% YoY). With the official Bank rate remaining at a record low and effective rates for personal borrowings still falling, loan repayments have never been so affordable. At present, the situation for personal finances is fine – household debt as a percentage to disposable income has fallen from a peak of 154% in the first quarter of 2008 to 132% in the fourth quarter of 2015. However, the risk is that the longer the BoE leaves interest rates unchanged, the more households (particularly the more financially vulnerable ones) will be encouraged to borrow. Inevitably, the strain on household finances will become more visible when interest rates eventually begin to rise.
The improvement in the availability of credit indicates that the UK financial system has been normalising following the post-crisis period, which is a positive development. However, in some areas, such as consumer credit and mortgage lending, current levels of activity may lead to greater financial instability in the longer-term. At the very least, the Monetary Policy Committee (MPC) and the Financial Stability Committee need to monitor these developments closely. More to the point, the strength of demand for credit lends support to the argument that the MPC should now be edging interest rates higher.