Personal loan rate uk

In this speech,(1) Sushil B Wadhwani(2) argues that the current rate of growth in household debt is unsustainable, but the vulnerability of the economy to rising debt should not be exaggerated. Australia and New Zealand have experienced significant exchange rate depreciations at a time when household debt rose strongly. So far, the impact on consumer price inflation and interest rates in these economies has been modest. He also notes that holding interest rates higher than necessary to hit the inflation target might lead to an even higher exchange rate, which may increase future inflation volatility and weaken the corporate sector

Introduction

Over the past two years, the world economy has been subjected to some significant disturbances. Global share prices fell, notably in the technology-related sectors. Then, we had the tragic events of 11 September, with its associated impact on confidence.

In recent weeks, sentiment appears to have improved significantly, with a variety of business confidence surveys displaying a notable rise. The sharp reduction of inventories that followed the September tragedy obviously could not endure, and, in a variety of countries, consumption spending remained relatively resilient. Consensus forecasts for global economic growth have been revised up in recent weeks, and there are some tentative signs that corporate investment spending in the United States may not be as weak in 2002 as many of us had feared. If the economy-wide capital stock overhang proves to be a little smaller than the consensus had feared, then it is not implausible to expect current forecasts for global economic activity to be revised upwards further. On the other hand, the downside risks to global activity remain. For example, the recent rise in the oil price is unhelpful, and events might take it rather higher. However, the resilience of the global economy to the shocks of the past two years has been awesome.

With the global economy looking better than one might have expected last autumn, I intend to devote some time to discussing some of the other key risks confronting the UK economy-specifically, the growth in household debt and the vulnerability of the exchange rate.

The growth in household indebtedness

A great deal of attention has focused recently on the issue of 'imbalances' in the UK economy. Concerns have related to the rather high pace of growth of household indebtedness, which may be associated with a worsening of the current account deficit that could eventually trigger a sudden correction in the exchange rate. Any such move might imply higher future inflation and could lead to a rise in interest rates. Some believe that this could lead to a 'bust' with a housing market crash.

While the current rate of growth in household debt clearly cannot be sustained indefinitely, there may be reasons to believe that the concerns about the

vulnerability of the macroeconomy to rising household debt might, at this point, be overstated. There has been a pick-up in recent years in the ratio of debt to income in the United Kingdom, but, as highlighted in Table A below, its level is not out of line with that in many other developed economies, and the recent rate of increase has been considerably higher in some countries (eg Australia and New Zealand).(1) Further, unlike in the United States, alternative measures of household debt-servicing ratios have been relatively stable over the past three years, despite the rise in debt (see Chart 1), and are still below their long-term average.(2)

In order for household income gearing (ie the interest rate measure) to return to the peak seen in the early 1990s, debt would almost have to double at current levels of interest rates or, at the current level of debt, interest rates would need to increase to almost 11%. Of course, it is possible to envisage circumstances where interest rates might need to rise considerably, but, in my personal view, the rise in the ratio of debt to income should make us more cautious about doing so.

It is also worth observing that the ratio of debt to financial assets in the United Kingdom has fallen from just over a third in 1990 to around one quarter in 2001 (see Table 13). In this context, note that the ratio of debt to assets in the United Kingdom is in line with the average ratio for the major six economies (M6), and that, indeed, the ratio of debt to assets rose during the 1990s in some other countries, including Germany, Australia and New Zealand.

The fall in the household savings ratio to a level below its historical average has also led to some concern about future consumption prospects. But the recent strength of consumption may, at least in part, be due to a low inflation environment. First, there is a measurement issue. The inflation-adjusted savings ratio is above its historical average (see Chart 2).(3) Second, there is a behavioural issue. It is plausible that the absence of index-linked mortgages implies that consumers react more significantly to fluctuations in nominal interest rates (with real interest rates held constant) than standard economic theory might imply. Certainly, back in the 1970s, economic forecasters were initially surprised by the weakness of consumption when inflation rose. The absence of index-linked mortgages implied that current mortgage-servicing costs rose steeply as inflation increased, and many consumers were forced to cut back even though the real duration of the loan fell,(1) ie the so-called front-end loading problem. Now, the significant fall in inflation has led to the situation being reversed, whereby the fall in current mortgage-servicing costs has enabled households who were previously liquidity constrained to consume more now. If this hypothesis is valid, one might expect lower inflation and nominal interest rates to be associated with a gradual rise in the ratio of debt to income to a new, higher equilibrium level, at which point this process could come to a halt relatively autonomously.

However, one concern that some of us have is that not all consumers are able to distinguish between real and nominal interest rates. Consequently, it is possible that some individuals might, in the years to come, be

surprised by the fact that debt repayments as a fraction of income do not fall as quickly as they did in a high inflation period. At that point, one would expect consumption to adjust, though it is unlikely to be abrupt.

Spending on durables and semi-durables has grown at a higher rate than overall consumption over the past year. Thus, the share of consumption accounted for by durables has surged recently, perhaps because of a desire by households to invest in physical rather than financial assets or because of falls in the relative price of these goods. Durables and semi-durables provide consumers with a flow of services over a number of future periods, unlike non-durables, which are consumed immediately. Data on household consumption record the value of new purchases. A more appropriate measure of consumer spending might adjust for this by dividing spending on durables and semi-durables by the life time of those goods. A savings ratio computed using such a measure of consumption shows a less marked fall than the conventional ratio.

Turning to the housing market, the ratio of house prices to average earnings is considerably higher than its historical average (see Chart 3) and this, at first sight, is worrisome. However, the ratio of house prices to total personal disposable income is only marginally higher than its post-1970s' average and is considerably lower than during the late 1980s. This might be a better guide to market valuation as, for example, it does allow for dual-income households. It must be noted that even on this measure, London house prices look stretched. But some other measures of housing affordability-for example, the interest cost of servicing a mortgage relative to income-remain below their historical average (see Chart 4), for the United Kingdom and London alike. This is obviously intimately related to our earlier discussion about the effects of low inflation. In the absence of index-linked mortgages, it is likely that lower inflation might boost the equilibrium ratio of house prices to earnings, because it reduces the initial cash-flow burden associated with a mortgage. Hence, at least some of the recent rise in house prices may well represent an adjustment to a new equilibrium. Having said that, of course, the current high rate of increrase in house prices clearly cannot be sustained for very long, and we shall remain vigilant.