Economics: Spenders lay down their debt burden

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The Independent Online
TWO of the most depressive factors at work in the economy are under unexpected attack. The continued fall in unemployment, now combined with a rise in jobs, is reassuring many people that their jobs and therefore their incomes are safe. At the same time, a structural change in the mortgage market is dispelling the fear of high debt. The result could be a quicker recovery.

The drop in unemployment in April is important. The first monthly fall in February could be dismissed as a freak. And March's fall could be shrugged off as a fiddle - maybe officials were meeting end-year targets for job placement. But the fall in April, small though it was, can no longer be explained away. Contrary to economic expectations and analysis, it seems likely the jobless trend is now flat, or even downwards.

The other evidence showing a labour market turn is also telling. Overtime is up, and short-time working down. Manufacturing jobs rose by a net 11,000 in the first quarter, an increase that is all the more astonishing because of the sharp rises in output per person (productivity) in that sector. It is too soon to tell whether this is merely some compensation for the panic-stricken job shedding last autumn, or whether it is the beginning of a longer trend. But the last Labour Force Survey showed a rise in services jobs in the fourth quarter. It may well have continued.

Nor is there any reason to be concerned about the recent 0.3 per cent drop in manufacturing output in March and in retail sales volume in April. Economic indicators rarely move solidly in one direction, and if they do it is probably time to start worrying about a boom or a slump.

Taking the first quarter as a whole, factory output is up by 2 per cent (an annualised 8.2 per cent) and retail sales volume is up by 1.6 per cent (an annualised 6.5 per cent). With growth rates like that, it would be surprising if the recovery did not pause for breath in the second quarter.

So the evidence is that the demand for labour is reviving. The other part of the unemployment story is that the supply of labour is shrinking. Both the Department of Social Security and the Department of Employment were at pains to stress that there had been no acceleration in the numbers of people claiming invalidity rather than unemployment benefit, and thereby excluding themselves from the labour force. But there are far fewer school-age children today than during the last recession, and many more 16 to 18-year-olds are staying at school. People are also retiring at a faster rate.

The impact of falling unemployment on the housing market may be particularly large. One of the main factors making first-time buyers reluctant to take the plunge has been fear for their jobs. If they now buy in large numbers, they will begin housing chains that will allow others to sell and buy in turn. As housing transactions pick up, demand for furnishings and decoration will also pick up. A virtuous circle is set up.

The second great weight gradually being lifted from the British economy is debt. The explanation of our prolonged recession, and of the failure of the economy to respond more quickly to big interest rate cuts both before and after our exit from the Exchange Rate Mechanism, is that people feel uneasy with debts that are twice as high compared with their incomes as they were in the early 1980s. Because they never want to be squeezed again in the vice so many people suffered in 1990 and 1991, they have repaid borrowing rather than spending money.

But there are two ways of allaying the fear of another rise in interest rates. The first is to repay your debt; the second is to ensure that the interest rate charged on it is fixed. Debt to income ratios remain very high, but the sharp fall in mortgage rates to the lowest level since 1968 means that interest payments to income ratios are down from a peak of 14 per cent to 10 per cent, roughly the 1988- 89 level. Thanks to the competition among mortgage lenders, particularly the banks, it is now possible to lock in those lower interest payments.

For example, Lloyds Bank is advertising fixed-rate mortgages that offer 7.99 per cent for five years, 8.99 per cent for 10 years or 9.75 per cent for 25 years. Borrowers can now insure themselves against the squeeze that has so far constrained their spending. A fixed-rate buys time during which normal earnings growth can humble the scale of the mortgage. Fixed rates could therefore help sustain spending.

But will they? The answer is a qualified yes. The fixed-rate market has taken off like a rocket.

According to the Council of Mortgage Lenders (CML), the proportion of all new mortgages that are at fixed rates has leapt from 22 per cent in the second quarter of last year (when many people insured against a Labour election victory by fixing rates at just over 10 per cent), to 30 per cent in the fourth quarter. This week's sample survey may show another jump - to around 45 per cent of new mortgages - in the first quarter of this year.

A similar structural shift has occurred in the United States. The US had a parallel experience of financial market liberalisation during the 1980s. There was a rash of borrowing that both individuals and companies subsequently regretted, and the very high US debt levels are the main explanation for its patchy and halting recovery. But fixed-interest mortgages have also taken off sharply on that side of the Atlantic, which is helping to bolster US consumption.

It is true, of course, that these figures apply only to new and refinanced mortgages. There is a far greater stock of old mortgages which is not being refinanced. However, CML surveys suggest that 24 per cent of all eight-million-plus mortgages have been fixed at some point. For some, the fix may have been for just a year or two. So a guess might be that 10 to 15 per cent of the total mortgage stock is now at fixed rates.

This is not negligible, and the proportion is growing rapidly. Moreover, the people who are fixing are probably those who feel most vulnerable, and where the impact on consumer spending may be greatest. This structural change, combined with the unemployment fall, may mean that consumer spending is more buoyant this year than most forecasters expect.

A strong revival of domestic spending would no doubt be welcome to the Government in the short term, because it would ensure that there is no relapse into recession - and it would improve the Tories' popularity. But a large part of the boost in spending would undoubtedly leak out into imports.

Since it would be occurring at a time when our export markets are depressed, the deficit on the balance of payments could balloon. Moreover, the Government's principal short-term weapon for dealing with such a rise in demand - an increase in interest rates - would have been blunted by the move to fixed rates. The structural change in the mortgage market therefore makes it even more important for the Government to use tax and public spending policy, rather than interest rates, to control domestic demand.

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