Crunch time for sales: Does the end of the debt bubble mean a sharp slowdown is inevitable?

As consumers tighten their belts, retailers are resorting to deep discounts to maintain sales.
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The Independent Online

Doom and gloom-mongers have been predicting a messy end to the consumer credit boom for much of the past three years. Ever since household debt passed the magic £1 trillion milestone in June 2004, a gaggle of politicians, consumer groups and economic analysts have been lining up to forecast a catastrophic hard landing to the consumer debt bubble – inevitably ending with a house-price crash, a sharp rise in personal bankruptcies and an eventual full-blown economic recession.

So far, however, no such scenario has materialised. Over the past 18 months, levels of unsecured personal loans and credit-card debt have slowly started to moderate – and while personal insolvencies have increased, they still remain at relatively low levels historically. Meanwhile, the wider economy is growing at its fastest rate for three years – 3.3 per cent on an annual basis – leaving Britain well placed to deal with any turn for the worse in the consumer economy.

But it's perhaps dangerous to take too much comfort from the statistics just yet. Howard Archer, the chief UK and European economist at Global Insight, suggests that the five interest-rate hikes over the past 16 months – the last of which was as recently as July – are yet to have had their full effect, warning that we are now on the cusp of a slowdown, both in consumer spending and the wider economy. "Going forward, people are going to need to continue tightening their belts," he said.

"We're forecasting growth to slow to 1.9 per cent next year – and one of the main reasons for that is we think consumer spending will be quite slow in 2008," he added.

According to the latest borrowing monitor report from Alliance & Leicester, homeowners have already started to tighten up over the past few months – payingthe balances on their credit cards much more aggressively than those without secured debt. Interestingly, this gap between homeowners and non-homeowners first started to open up in the third quarter of 2006 (see table right), when the Bank of England made the first of its five rate rises. And in the second quarter of 2007, when the fourth of the five rate hikes was made, the gap grew wider still, with unsecured lending by homeowners slipping into negative growth.Although a price war in the loan market saw interest rates stay low, even as the Bank of England base rate rose, homeowners have clearly felt the pinch after a 25 per cent rise in their mortgage payments, and now appear to be steering clear of unsecured lending.

"Families are cutting back on their borrowing and their saving to help ensure they can afford higher mortgages and other household bills," said Sean Murphy, the director of strategic planning at A&L.

"Even though average interest rates on unsecured borrowings have actually fallen over the past 12 months, that has not been enough to tempt mortgage borrowers to take on more unsecured debt. Their family budgets have been under pressure and they have cut their cloth accordingly."

As yet, the effects of this tightening do not appear to have permeated through to top-line sales on the high street. However, the latest retail spending statistics did reveal a sharp fall in prices, suggesting that the sustained growth has been fuelled only by price wars.

Furthermore, while the A&L report suggests there is still some appetite for borrowing from those who do not have mortgages, Mr Archer points out that the credit crunch is likely to make loans harder to come by. "There's no guarantee that the credit crunch is going to disappear anytime soon," he said. "So you might find that some consumers are finding it harder to borrow, and that those who are borrowing are being forced to pay higher rates."

Already, the days of sub 6 per cent loans are over and, according to recent research from Moneyfacts, the financial comparison website, more than 30 lenders have put up their loan rates over the past three months – by an average of almost 1 percentage point.

Mr Archer adds that the slowdown in the housing market, which is already underway, could be accelerated by the credit crunch, further damaging consumer confidence. "When house prices rise, it makes people feel richer, so it encourages people to borrow more," he said. "So when they fall, the opposite is true."

As house prices fall, the amount of money that people can withdraw from their homes will also fall. Sales of equity release plans were up 16 per cent year-on-year during the second quarter, but if house prices fall, homeowners are likely to feel less inclined to draw on the capital in their property.

Nevertheless, while a continued slowdown in consumer borrowing and spending looks likely, there is still little to suggest this may trigger a recession. In a new report published tomorrow, analysts at Datamonitor will predict that the slowdown in consumer credit is unlikely to last much beyond the end of this year.

Maya Imberg, the report's author, said she expects to see a slow revival in 2008 and beyond. "A lot of people use credit cards as a payment method – even if they pay them off every month – and I think that will continue," she said. "And people will still need personal loans for things such as cars."

Ross Walker, an economist at the Royal Bank of Scotland, says he believes that while a fall in consumer spending now seems inevitable, the resilience of the wider economy is likely to depend on whether employment levels are maintained as we head into the slowdown.

"If employment levels remain high, as happened during the two previous mini slowdowns of 1995 and 2001-2, I think this will be a soft landing and consumers will be able to repair their balance sheets," he said. "However, if the labour markets turn, it could be a lot more uncomfortable.

"A lot of the recent job growth has been in the financial services and other business sectors, and conditions may be less buoyant for these companies going forward. So a lot of it hinges on whether employers perceive it to be a relatively mild downturn and hold on to their workforce," he argued.