Hamish McRae: Till debt us do part - but can Bank ease a social and economic problem?

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The Independent Online

How worried is the Bank of England about debt? Our debt, that is - for the average adult Briton owes more than £23,000. Quite a lot of money, and I should think quite a headache for the Bank as well as the borrowers.

The headline stuff in the Bank's new Inflation Report, out yesterday, is the downgrading of concern about inflation from the previous report in August and its increased concern about the impact of higher taxation on consumption. The first is obviously encouraging, carrying as it does the possibility of some further fall in interest rates next year - or at least giving the Bank leeway to cut rates if it needs to. The second is less cheering: the fact that people have to spend money on necessities such as public utility bills, petrol and taxation, rather than fun things such as good restaurants and expensive clothes.

But behind the obvious "what is happening to the economy?" story is a less obvious "what is happening to debt?" one. Central banks are always concerned about the consequences on debtors during any tightening phase, just as they are worried about excessive borrowing when rates are down.

Getting the line right is terribly difficult. Central banks have only one variable under direct control: short-term interest rates, coupled with the impact, such as it is, of speeches by the members of the rate-setting body. They cannot control long-term interest rates, the currency, the price of energy, the Government's tax policies, or the growth of export markets and so on. Worse, they don't know the length of the time-lags between any action they take and the impact on borrowers and lenders alike.

Last year, the principal aim of monetary policy was to put the lid on house prices. That is not what they say was the aim, which was to fix interest rates at a level which would keep inflation within the target range - the legal requirement on the Bank. But in practice that meant ending the housing boom without provoking a crash. Get the housing market right and everything else would more or less take care of itself. Get it wrong and there would be trouble.

Well, it looks very much as though the Bank did get it right and all credit to its Monetary Policy Committee for so doing. Then this summer it looked as though the Bank might have over-cooked it and lent too hard. So rates were cut, a narrow majority decision that was controversial at the time but now looks quite right given the reduced expectations for inflation.

So rates are starting to come down, which ought to make debts easier to service but, of course, the great mass of debt remains and that eventually will have to be repaid. The scale of this debt is shown in the pie-chart. Secured debt is almost entirely mortgages, the point being that there is an asset against the debt. It is huge but then so is housing wealth. Providing people can service their mortgages, all will eventually be well.

But there are starting to be signs of strain. The next graph shows that while actual repossessions remain very low, the leading indicators - actions entered to repossess and orders made to do so - have started to climbed quite sharply. The problem is nothing like that of the early-1990s cycle but we are still in a period of full employment and reasonably solid growth. In any case, in human terms any repossession is a disaster and any rise at all should make us uncomfortable.

At least mortgage rates are low. Interest on other forms of debt is not. The other two bits of the pie are general unsecured debt, mostly consumer credit of various sorts, and credit card debt. General unsecured debt costs on average a little less than 10 per cent and has been stable through this interest rate cycle. You may think that is pretty high when the cost of money to the lender is less than 5 per cent, but it is convenient and easily available. It carries risks of non-payment and good borrowers have therefore to pay for bad ones.

The effective rate on credit cards is even higher. It has also risen in the past 18 months, from about 10 per cent to 11.5 per cent. Some people pay much less, for several reasons. Some types of credit card charge less; some people pay off in full each month; and others - the so-called "rate tarts" - juggle payments to take maximum advantage of introductory interest-free periods when they switch card debt.

Leaving aside the dubious use of a somewhat offensive term for what seems to me to be a rather shrewd approach to borrowing, the mathematical logic of some people paying less than the average is that others are paying more. A lot of people are paying 15 per cent and upwards on credit card debt. If, on average, we have debts of £1,168, and some of us hardly borrow at all, the debts of others must be huge.

This is an actual social problem as well as a potential economic one. It is an actual social problem because those least able to afford high interest rates pay the most. It is a potential economic problem because all that is needed to push consumption growth down sharply would be for people to stop increasing their borrowings - consumption takes a hit even without people starting to pay back debt.

The final graph goes back 30 years, to the tail-end of the early-1970s' oil shock. As you can see, there have been only three periods when consumption has not grown: in 1975, in 1981 and in 1990-92. These coincide, interestingly, with periods when house prices have fallen in real terms. We are again in a period where house prices have more or less stopped growing and look like stagnating for a while. And as the Bank's Governor, Mervyn King, said yesterday, rising taxes are already squeezing consumption.

So there is a pincer movement on consumers: the need not to borrow more (and maybe pay back a little) on the one hand, and higher taxation on the other. It is a monetary and fiscal squeeze. In the coming couple of years, the Bank will have to nudge rates down to minimise the monetary squeeze and, fortunately, it has room to do so. But there is nothing it can do about the fiscal squeeze, nor should it want to. Tax policy is nothing to do with the Bank.

We will know more about how the Chancellor intends to cope with his fiscal problems in the forthcoming Pre-Budget Report. The danger is that he will force us to tighten our belts even further just at the moment when we conclude it might be a good idea to back off some debt. Growth this year has been only half that expected by the Treasury. If the pincers tighten, do not expect much of a pick-up in growth next year.