Should we be concerned about a falling savings ratio?

In the Bank of England’s latest forecast for the UK, they predict reasonably good economic growth in term of real GDP. At the same time, forecasts for average real incomes are more pessimistic. The Bank of England suggests UK economic growth will be maintained by consumer spending – spending which will partly be funded by a decline in the savings ratio. Essentially, real wages are forecast to stagnate (or grow slowly), but higher spending will be financed by lower saving.

Forecast-fall-in-savings-rate Source: Bank of England Inflation report Feb 2017.

What is happening?

Firstly, a significant element (average of 31% in recent decade) of the increase in real GDP is due to population growth. More people, higher total income.

real-income-per-capita-quarterly

Real GDP per capita and real disposable income are increasing at a slower rate than headline real GDP. See more at Real GDP per capita

Secondly, since the Brexit vote, consumer confidence has been relatively robust, this has led to consumers maintaining spending levels but by partly reducing their savings.

The depreciation in the Pound which occurred in 2016, is likely to, increasingly, feed through into higher prices on the high street. The Bank is predicting that consumers will respond to this cost-push inflation by continuing to spend but reducing their savings to finance the expenditure.

Should we be concerned by this fall in the savings ratio?

By dipping into savings, consumers are helping to maintain domestic demand and boost economic growth. This increase in spending helps various macroeconomic factors, such as employment, government borrowing and business confidence.

Without a fall in the savings ratio, we would see lower consumer spending, and this could lead to a sharp slowdown in the economy; this could create a negative multiplier effect, leading to rising unemployment and lower growth.

The hope is that the cost-push inflation resulting from depreciation will be temporary and in the future, the inflation rate will reduce; therefore, in the future, this will enable workers to see real wage increases and rebuild their savings.

From an optimistic perspective, a fall in the saving ratio can be seen as a temporary shock absorber for the temporary increase in prices.

Potential problems of fall in savings ratio

saving-rate

Firstly it is not a good omen for the saving rate to fall to a level last seen in 2008 – just before the financial crisis. It indicates households are stretched – some only managing to meet bills through borrowing and spending on credit. The effect of this fall in the savings ratio also means households will be more vulnerable to any future demand-side shock. For example, with households increasing their levels of credit, even modest rises in interest rates (to deal with the high inflation) could lead to a significant fall in discretionary income and a slowdown in spending.

Sharp rise in consumer credit in recent years

rise in consumer credit

Source: Bank of England Inflation report Feb 2017.

Alternatively, we could see some external shock from a decline in global trade – resulting from a tariff war or impact of Brexit.

A lower saving ratio also has an impact on the long-term performance of the economy. Lower savings means banks have a lower level of funds to finance investment. The UK economy is currently suffering from weak productivity growth. Many analysts argue we need more investment to catch up with new developments in technology, automation and shifting economic trends.

Lower savings ratio may also have implication for government borrowing. In theory, with lower levels of private sector savings, there will be fewer funds to buy government bonds – it could cause government bond yields to start to rise from current low levels.

In the short-term, the fall in the savings ratio will help maintain positive economic growth. But, from a longer-term perspective, the UK economy has been too reliant on low savings and high consumer spending to sustain economic growth.

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