We’re back in the old growth model
Today the OBR revised growth up due to big increases in their consumption forecasts.
At the same time they revised down their forecasts of average earnings growth.
So, simply put – households are now expected to spend more but earn less than was the case in March.
This fits the pattern of the recovery we have experienced over the last year or so – consumption driven accompanied by weak earnings growth with the factor making the difference being a falling household savings ratio.
The additional detail from the OBR today – buried away in the supplementary spreadsheets – make clear that they expect this pattern to not only continue but intensify.
The chart below looks at the household sector financial balance – expressed as percentage of GDP. If this is a positive number the household sector are (in aggregate) saving and acting as net lenders to the other sectors (corporate, government, rest of the world). If this number is negative than the household sector is borrowing from these other sectors.
The new OBR forecast are in red and the March 2013 Budget forecast are in blue.
As can be seen the picture has changed drastically. At the time of the Budget the OBR expected households to gradually reduce their net lending to the rest of the economy until 2016 and then become net borrowers.
It now expects the sector to be net borrowers by mid 2014 and for this trend to intensify all the way out to 2018.
George Osborne once promised a ‘new economic model’ build on savings, exports and business investment. It seems when push comes to shove he is happy to return to the ‘old model’ of consumption and household debt.
So I foresee three possible scenarios for the UK economy in the next three or four years (in the absence of rapid rebalancing towards a net trade or investment led recovery and in the absence of a change in fiscal or monetary policy):
- First, and most preferable but most unlikely, we get strong growth in real incomes as inflation falls back towards 2% and wage growth increases. If that happens consumption growth will be stronger and the economy will grow at a decent pace.
- Second, and what I think is the most likely outcome – my central ‘forecast’ if you will – household income growth will be weak and the savings ratio will not drop by much. The result will be weak consumption growth and an economy that is growing, but growing slowly – in the order of 1-1.5% a year. In historical terms of recovery from recession this is pretty much a disaster.
- Third, it is possible that we still get weak income growth but that the savings ratio drops rapidly. In this scenario we’d see faster consumption growth and hence faster overall growth. This however would be accompanied by a big increase in household debt. It might give us 3 – 4 years of decent growth, but at the risk of increasing the financial imbalances that got us into trouble in the first place.
I hope for the first outcome, expect the second and worry about the third.
We are now firmly on the path to that third scenario.