A recent report from the Financial Times shows that UK credit card debts have climbed to record highs as consumers have attempted to retain their living standards amidst the UK’s cost of living crisis.
With the UK rate of inflation reaching 6.2% CPI in February, an increase from 5.5% CPI in January, inflation rates are well above the 2.0% CPI target as the UK economy is beginning to enter a stage of near-full capacity, evidenced by a 3.9% unemployment rate in January, which, is in the middle of the 3-5% naturally occurring rate of unemployment.
This smaller output gap has occurred due to both cost-push and demand-pull factors. Due to the COVID-19 pandemic, global supply chains saw an unpredictable shock, and, countries such as China are still experiencing lockdowns at their ports that are increasing shipping and trade costs, which, is significant as 31.5% of the UK’s GDP is allocated towards imports, according to the CIA’s World Factbook, meaning that any fluctuation on international shipping costs will have a large effect on cost-push inflation within the UK.
As such, because costs of production have risen within the UK due to a continuation of lockdowns, and, with the Russia Ukraine crisis further increasing the cost of commodities such as gas and oil, cost-push pressures have worsened, which, has led to an increase in inflation rates as well as a reduction in the UK output gap as aggregate supply levels have fallen.
At the same time, with low levels of unemployment and higher wage growth of 3.8%, aggregate demand levels have also risen, leading to a further reduction in the UK’s output gap as aggregate demand rises, also yielding demand-pull inflation.
However, although UK nominal wage growth has risen by 3.8%, real wage growth is at -1% in January 2022, meaning that in real terms, on average, UK consumers have seen a fall in their real disposable incomes. This is more of an issue for those who do not see a rise in incomes at all, those on fixed incomes, such as JSA or state pensions, who, will see an even bigger reduction in their standards of living as higher rates of inflation reduce real disposable incomes forcing consumers to switch from normal to inferior goods.
As such, to maintain living standards, consumers have resorted to borrowing on credit. This is typically a last resort as prior to borrowing, consumers will typically downgrade their living standards from going from normal to inferior goods, yet, due to the cost of living crisis, consumers have gotten to the point where they cut back altogether. Certain families, such as ones that are classed as JAMS, Just About Managing, have gotten to the point where they face terrible opportunity costs associated with heating or eating. In this case, credit cards are the only alternative available aside from charity for consumers to continue to maintain a basic standard of living to prevent absolute poverty.
“Weak sentiment also indicates that the big rise in consumer borrowing in February likely reflects households attempting to maintain their consumption at a time when real disposable income is falling sharply, rather than them going on a spending spree,” said Samuel Tombs, chief UK economist at consultancy Pantheon Macroeconomics.
In February, Consumers borrowed £1.5bn, which is the highest monthly figure since statistics began in 1993. This figure is more than three times higher than the average of £400mn borrowed in the previous six months and pushed total consumer credit to £1.9 billion, the highest in five years.
With so much consumer debt circulating within the UK economy, consumers must be confident that the economy will remain on its path of recovery despite uncertainty surrounding the Russian and Ukraine crisis as a potential economic downturn will lead to an incredibly painful recession as those most vulnerable in society will be unable to repay their debts, a pattern which could lead to debt-deflation in an economic downturn.
At the same time, with the cost of servicing debts rising due to the Bank of England's interest rate hike from 0.5% to 0.75%, a pattern that will likely lead to further rate hikes, in long-run, consumers will bear an increasingly negative opportunity cost associated with the debt repayments as rising interest rates will continue to eat into consumer disposable incomes.
A lack of fiscal support from the UK government from the recent Spring Statement has essentially led to consumers having to fend for themselves by borrowing via credit. Although this has led to consumers being able to retain their living standards in short-run, in long-run, this will lead to a worsening opportunity cost, which, poses a threat to the UK’s economic recovery especially if the Russia Ukraine crisis will yield an economic downturn.
Written by Hubert Kucharski