If you’re unfamiliar with the macroeconomic climate, it’s quite fascinating to study precisely how this works. In simple terms, this refers to the branch of economics that analyses how the aggregate economy behaves, including the interaction between measures such as inflation, interest rates and gross domestic product (GDP) growth.
In the current climate, it’s been particularly interesting to review the relationship between consumer debt and interest rates. While artificially low interest rates encouraged spending and fuelled the rise in consumer debt throughout 2017, for example, the subsequent Bank of England (BoE) hike at the end of last year increased the burden facing customers.
In this post, we’ll review this relationship in further detail, while asking what this means for customers and the economy as a whole.
Charting the Last 18 Months – The Precarious Balance between Consumer Debt and Interest Rates
For more than a decade following the Great Recession, the BoE refused to raise the base interest rate and kept this fixed at 0.25%. The objective of this was clear; as the BoE looked to encourage consumer spending and drive economic growth in a deceptively challenging climate
This approach began to share dividends in some respects last year, as consumers borrowed more and increased the amount that they spent across a wealth of industries and marketplaces. As the UK saw its cumulative consumer debt burden increase to £200 billion during this time, however, economists began to suggest that this may be unsustainable over any concerted period of time.
Then, in November of last year, the BoE took the largely unexpected and controversial decision to increase the base rate to 0.5%, bringing it in line with North America’s Federal Reserve and the European Central Bank (ECB). As a result, the amount that customers were forced to repay on unsecured debts suddenly increased, causing an incremental hike to their burden and one that some may have struggled to cope with.
When you also consider the impact of stagnant wage growth and a disproportionately high inflation rate of 2.4% (which is far above the BoE’s target of 2%), even this relatively small increase has put the squeeze on consumers while arguably trapping those who had been previously encouraged to spend in a recurring debt cycle.
How will this Relationship Evolve in the Near-term?
Some have pointed to an obvious contradiction in the BoE’s approach, while criticising the timing of the base rate hike. After all, spending and borrowing had been encouraged to the point where debt levels were causing considerable concerns, with the rate hike seeming to compound this issue and leaving households struggling to service their debt.
It’s interesting to note that the BoE has refused to unveil any further hikes since last November, as disposable income levels in the UK have fallen to their lowest level since 2005. This created a scenario where customers and households could scarcely afford another base rate hike, particularly while attempting to service their debt across both unsecured loans and variable rate mortgage agreements.
So, while a further hike to 0.75% has been mooted for August, for now customers have been allowed a period of consolidation as the BoE look to balance the needs of debtors with the stimulation of economic growth.
The Last Word
While households may ultimately choose to reduce the impact of interest rate hikes by consolidating their debts into a single, manageable payment, it’s also important that businesses pay heed to consumer debt levels and the strategy deployed by the BoE.
After all, negative sentiment, rising debt and decreased borrowing will have a negative impact on spending, potentially forcing businesses to adapt their pricing strategies. Even though the base rate has remained unchanged since November, a further hike next month could create even greater uncertainty and have a detrimental impact on business growth.
We must wait and see what August brings, of course, but there’s no doubt that the relationship between consumer debt and interest rates is creating a difficult challenge for the BoE in the current climate.
