Expert View; All the signs point to the end of the years of plenty

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The Independent Online

Consumer spending has, in consequence, grown faster than personal incomes, and faster than GDP. Between 1992 and 2005, the average annual GDP growth was 2.8 per cent while consumer spending growth was 3.1 per cent.

The past bullishness of consumers has been related to the long rise in house prices. Recent work by PricewaterhouseCoopers shows that the two main drivers of consumer spending are real disposable incomes and house-price inflation. House prices have risen relative to incomes due to falling long-term interest rates, but that benign process may now be at an end.

The story starts in the 1970s, when long-term interest rates were driven upwards by inflationary pressure to nearly 15 per cent. The tough policies of the Thatcher years drove inflation back down into single figures, but it took a long while to persuade bond holders, robbed by inflation in the 1970s, that the reduction was permanent. Confidence in bonds returned fully only in the 1990s, as a track record of low inflation was finally established. The spread of inflation targeting and central bank independence helped procure a steady fall in long-term rates through the decade.

The pain of the 1980s delivered gains in the 1990s. When long interest rates fall, the value of houses and shares rises, because the net present value of the stream of income they deliver goes up. The fall in long (real) interest rates thus helped to create the buoyant stock and housing markets of the 1990s. Since 2000, UK interest rates have continued to fall in real terms, but they are now close to historic lows.

So house prices have been driven up, at least in part, by a bond rate adjustment that has largely run its course. Despite the cut in short rates, house-price inflation will probably be lower in future. Indeed, if house prices have overshot their equilibrium, they could now fall in real terms. That does not mean a crash. The correction could occur via a long period of sluggish (or zero) growth. But if consumer spending depends on house-price inflation, then it too will grow more slowly in future than in the past.

The other key determinant of consumer spending - real disposable income - could also be at a turning point. The size of the government budget deficit means that taxes are more likely to rise than to fall, reducing the growth of disposable income. Furthermore, real personal income has been boosted relative to GDP over the past 10 years by a 3.7 per cent improvement in the terms of trade. There is no guarantee that that will happen again.

If longer-term prospects for consumption are less bright than before, those for retail sales are worse. Real growth has fallen from 7 per cent to 2 per cent this year. Retail sales account for only a third of consumer spending and currently it is the less buoyant part. People spend freely on services: mobile phones, gambling, financial services and holidays. They spend much less freely on goods, and buy an increasing proportion of them online rather than in the high street.

The decline in retail sales growth is thus partly caused by two adverse long-run trends: lower growth in consumer spending as savings ratios stabilise, and a change in patterns of consumption away from goods bought in shops. Neither of these trends will be changed by the Bank's actions last Thursday.

Bill Robinson is director of economics at PricewaterhouseCoopers