Bank blames high household debt for depth of Britain’s recession

Fears are growing that household borrowing is set to start climbing again as the economy recovers

Gross household debt reached a historic high of around 160 per cent of combined incomes in 2007 (Rex Features)

Britain’s recession was the deepest and longest in post-war history because households were so heavily indebted going into the crisis, new research from the Bank of England today suggests.

Bank researchers said that an analysis of “microdata” on UK households’ finances shows that those with high levels of debt in 2008 cut their spending by more, relative to their incomes, than others.

And because gross household debt reached a historic high of around 160 per cent of combined incomes in 2007, these spending cutbacks had a profoundly negative impact on demand when the downturn came. This debt overhang increased the depth of the recession and made it much longer than previous ones.

The finding has implications for Bank policymakers today because of rising concerns that household borrowing is set to start climbing again as the economy recovers and house prices shoot up.

The Bank’s Financial Policy Committee took action in June to ration the number of high loan-to-income mortgages that commercial banks can grant each quarter.

The vast majority of the build-up in debt in the years before the crisis was a result of people taking out mortgages to buy increasingly expensive homes, rather than households borrowing to fund day-to-day consumption.

But the Bank said there was also an increase in equity drawdown in the years before the crisis, which might have helped to finance consumption spending.

“It is possible to make the case that debt played at least some role,” researchers write in the latest edition of the Bank’s Quarterly Bulletin.

They estimate retrenchment by households was responsible for around two-fifths of the total reduction of the fall in aggregate private consumption after 2007.

The latest estimates from the Office for National Statistics (ONS) show the economy fell by around 6 per cent in between the first quarter of 2008 and the third quarter of 2009.

The ONS estimates the economy finally regained its 2008 peak in the second quarter of this year. This is likely to be brought forward by 12 months when methodological revisions to the national accounts are finalised later this year, but that would still make the recovery the slowest on modern record.

The Office for Budget Responsibility, the Treasury’s official forecaster, predicts that the household debt-to-income ratio will rise steadily over the next five years, returning close to the pre-crisis peak.