The UK economy is generally described as a consumer economy. This means that its health is significantly dependent on and measured by how households spend or save their income.
The effects of changes in consumer spending behaviour can be dramatic for businesses as my July 2018 Key Indicator on the retail sector demonstrated.
But consumer spending behaviour is not simply directed by a change in habits and tastes. In this month’s Key Indicator, I look at those factors that affect how much disposable income is available and how this influences spending decisions.
The majority of consumer income is earned as salary or wages from employment.
This may be topped up by benefits, such as the tax credit system for households with children, where family income is low. This was restricted to being payable for the first two children only, following various adjustments to state benefit rules since the 2008 financial crash and the introduction by the Government of various “austerity” measures as part of efforts towards economic recovery.
For the retired, household income generally comes primarily from state and occupational pensions.
Household income may also be topped up by interest and dividends from any savings but recently these have been low, none the least due to the unprecedented low levels of interest rates.
The factors that affect disposable income and therefore consumer spending
There have been several worrying indicators that consumer spending has been sluggish throughout 2018, and this has a significant impact on the health of an economy like the UK’s.
The most recent figures published by the Office for National Statistics (ONS) on household consumption are for the first quarter of the year, from January to March. Although there is always a time lag in publication they are indicative of a longer-term trend.
Consumption remained subdued at 0.2% in Quarter 1 2018 according to the ONS and in 2017 annual growth in household consumption remained at its weakest since 2012. The ONS reports that this is “consistent with the slowdown in output for consumer-focused services industries, which has been on a declining trend since late 2016.”
The factors that are likely to have affected this are the weak growth in real wages, with household incomes squeezed by rising import prices following the past depreciation of £Sterling following the 2016 Referendum vote to leave the EU.
According to the ICAEW (Institute of Chartered Accountants in England and Wales) sluggish wage growth at on average 2% in the face of a near- 3% inflation rate is also a major factor in the squeeze on household incomes. This is despite unemployment being at its lowest level since the early 1970s and therefore the existence of a skills shortage in some sectors. But it is outweighed by the existence of such things as tax and benefit reforms, the growth of the “gig economy” and zero hours contracts that have changed the employment landscape for both businesses and employees and in turn reduced the reported level of unemployment statistics.
Kamal Ahmed, the BBC’s economics editor says he looks at two statistics when examining people’s finances. These are firstly whether they are net borrowers or net lenders, and secondly at their savings ratio.
Net borrowers are either borrowing, or spending their savings, to make ends meet. Net lenders are those “lending” money to the economy in the form of pension contributions, savings and investments”.
The savings ratio is the proportion of people’s disposable income that they save. Here again there are worrying signs in the most recent ONS data. The savings ratio is currently at 4.1%, the third lowest since records began in 1963.
As I reported in my blog on Tuesday (July 31) the most recent statistics from the Insolvency Service, on the second quarter of the year, April to June 2018, also revealed a worrying indicator on individual and household finances. This was that numbers of individual insolvencies had reached their highest level since the first quarter of 2012 and had increased by 4.4% compared with January to March 2018. Again, this has been an upward trend for several months.
According to the ONS British Households spent on average £900 per year more than they received in income in 2017 and there are signs that people are increasing their borrowing. There are three main sources for personal lending which are all growing: credit cards, finance for capital items like cars, and payday loans. Most of this debt is not to buy luxuries but simply to make ends meet since so many people live paycheck to paycheck.
The implications for SMEs of a potential change in consumer spending habits
Clearly the retail sector is the first to feel the effects of changes in consumer spending and arguably the shift to online purchases has not only been because of the convenience but also because buying goods online can often be less expensive.
Equally the rise of the budget food stores, such as Aldi and Lidl, suggest a shift in food shopping habits to make household incomes stretch further.
There may also be signs of a shift in the travel and tourism sector based on fewer people taking holidays abroad and instead having “staycation”. This is something I shall be exploring in a focus on the sector later this month although there may be other factors at play here as well.
Clearly, though, the pressures outlined in this blog on household incomes would suggest that unless things change to improve our national economic prospects there may be a longer-term shift in consumer spending habits.
Those businesses that rely on consumption should not assume this is a temporary blip.
Given the changing circumstances it will be essential for those of you in this sector to review and adjust your business models, your marketing plans and your products and services in order to safeguard your business for the future.
Stop press: it remains to be seen what effect today’s Bank of England Interest rate increase, from 0.5% to 0.75%, will have on consumer spending but it is likely to affect all those with variable or tracker rate mortgages making disposable household income even tighter.