The single most important factor influencing most decisions on retail spending and spending on services is the level of household income after payments of capital, interest on debt and other non-discretionary payments bills of various sorts have been made. We call this discretionary income. Our estimates suggest that UK household discretionary income growth has declined significantly, growing by only 0.5% in 2004. This low growth may provide a key insight into why retail sales growth is currently subdued.
In 2001, nominal retail sales spending rose 5.9%. In 2004, by contrast, nominal retail sales spending rose 4.7%, but in April this year, growth slowed to only 1.2% year on year. There are several potential explanations for this, and discretionary income growth does not have to slow for the consumer to slow their spending. However, several factors have had an impact on the discretionary income of households in recent quarters including energy bills and mortgage payments.
Mortgage payments are more of a burden. Household debt servicing ratios have risen significantly. Household average regular monthly mortgage principal repayments and debt interest payments reached £318 in Q4 2004, up from only £255 in 2003. Growth in average household debt servicing has outpaced growth in average earnings.
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The roll-off of two-year fixed mortgage products in 2005 may also slow spending growth. Using some simple assumptions, this factor alone could subtract some £0.5bln from discretionary income this year: If two-year mortgage rates remain at end-May levels, the average difference in the interest rate for borrowers renewing two-year fixes in 2005 would be around 70bp; 2003 household secured lending was £277bln; £42110bln was fixed at two-year maturity. Using a simple mortgage repayment calculation, annual repayments on £110bln, at 4.5% (the average quoted two-year rate over 2003) would have been £8.3bnl. If two year fixed rates were to remain at May 2005 levels (5.2%) we estimate that these annual payments would rise to £8.8bln. However, we cannot attribute the recent subdued growth in consumer spending to this factor alone. The £0.5bln calculated is equivalent to only 0.1% of 2004 gross disposable household income.
Energy bills. An unexpected rise in energy prices has a direct impact on spending. In our recent research we estimated that a 10% permanent rise in real energy prices would negatively affect real consumer spending on all major categories of consumption except energy.
Household spending on fuel and electricity/gas was some 4.4% of total household consumption in 2004. Including transport services (one of the sectors we might expect to reflect higher fuel prices relatively quickly), brings that to 8.1% (approximately £2,400 per year, per household). Nominal spending on these items rose by 6.2% in 2004. Using Morgan Stanley forecasts for oil prices, our central expectation is that energy prices faced by UK consumers in 2005 will be, on average, nearly 8% higher than in 2004.
Mortgage equity withdrawal a factor. Mortgage equity withdrawal (MEW) forms a link between housing wealth and consumer spending and may also help to explain current subdued high-street spending growth. MEW is intended to measure that part of secured borrowing not invested in the housing market, for example, when a borrower takes out a new increased mortgage without moving to a new house. Surveys suggest a significant amount of MEW is spent, but not precisely what proportion. Nevertheless, with MEW down 59%Y in Q4 2004 at £6.9bln, this may help to account for some of the recent rather subdued spending growth.
Household discretionary income growing more slowly. The national statistics framework for analysing discretionary income revolves around disposable income which, broadly, takes wages and salaries, adds net social benefits and net interest received, and takes off taxes. Consumers, however, may have a different concept in mind, more a household budget' where principal payments on debt and utility bills, for example might also count as non-discretionary spending'.
Our estimate of the change in discretionary income was only 0.5% over 2004 (suggesting negative growth in real terms), and it fell year-on-year in Q4 by 0.6%. Growth in average household discretionary income appears to have declined for several reasons: 1) a smaller rise in wages and salaries; 2) smaller increases in benefits; 3) a bigger rise in net interest payments.
Significant rises in wages and salaries cannot be ruled out (the unemployment rate is at almost a 30-year low). But so far this year, ex-bonuses earnings growth has actually been declining. Meanwhile, interest payments on debt will probably continue to rise, even if the Bank of England does not raise rates again this year, given the fixed-rate rollover' factor and the fact that the stock of debt continues to grow.
Implications consistent with consumer slowdown. The reduction in the growth of household discretionary income in 2004 compared with 2001 may help to account for some of the slowdown in retail sales and other spending indicators over that period. With underlying earnings growth apparently slowing and interest payments on debt likely to continue to rise, this retail spending slowdown may have a little further to run and suggests downside risks to our central real consumer spending growth forecast (currently for 1.7% growth this year after 3.3% in 2004)
By Melanie Baker, Morgan Stanley Economist, in The Global Economic Forum
