Kleinwort Benson: The UK consumer – under attack from all sides
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THE living standards of the average UK household are being squeezed in every direction, and this, as the Governor of the Bank of England recently reminded us, is the unwelcome but necessary outcome of the end of the debt-fuelled spending boom of the first seven years of this century. In the first place, unemployment has risen as companies sought to cut back in the face of lower demand, and is likely to rise further as the new financial year sees public sector workers being made redundant in order to meet tighter budgets. Secondly, for those in work, pay increases have become a rarity – across the whole economy average earnings increases have fallen from about 4.5% in 2007 to about 2% now. Thirdly, the poor returns from equity markets combined with the decline in bond yields have meant that many defined benefit pension schemes are in substantial deficit and employers are increasingly resorting to higher pension contributions from workers to help to plug the gaps. Similarly all workers in the public sector are having to increase the contributions that they make to their pensions – these higher contributions lead to a decline in take-home pay. Once the money has been “taken home”, it simply does not go nearly as far as it used to. Mortgage payments are on the rise for several reasons – firstly the ultra-competitive interest rates that banks were offering on 3 year deals in 2007-08 are expiring and the best rates today are reserved only for those with substantial equity in their homes (after house prices have fallen) – this is because most of the foreign banks operating in the market in 2007 have pulled back from the UK market. Secondly, the banks that are left need to make much larger profit margins on their business than before in order to rebuild their balance sheets after the severe losses of previous years – thus their Standard Variable Rates have been rising. Thirdly, interest rates in the money markets have been rising on speculation that the Bank of England will start raising interest rates soon – this has pushed up the cost of fixed-rate mortgages. So mortgage payments have begun to increase. For renters the picture is only a little better – house prices remain expensive relative to average incomes because there is an underlying shortage of houses and flats in the economy, particularly in the South-East – with fewer people able to buy homes, more are forced to rent but with still constrained supply, housing rents in the South-East are also rising. Then comes energy costs – over the last two years the oil price has risen by 170% from $42 to $113 per barrel – this will continue to feed through into both gas and electricity prices for some months to come. The last $10 of this rise has come about due to Middle East tensions, which may be temporary, but equally may not – it is by no means clear that we have completed this round of revolutions, nor is it at all clear what sort of regimes will replace those which have been defeated, and what their attitudes to their oil production will be. As has been well documented, the end of last year saw startling increases in the prices of many agricultural commodities – wheat, sugar and corn being both key staple commodities and those seeing the largest increases. Food prices are rising sharply all over the world. Having absorbed all these hits to their disposable incomes, for the last two Januarys, the government has put through a 2.5% increase in VAT, which is payable on just about every other item of expenditure other than those already mentioned. Many of these hits to disposable income are part of the fiscal austerity, but the others have been caused by rising commodity prices which are occurring with exquisitely bad timing and so intensifying the squeeze on living standards in the UK. The dreadful weather in November and December kept consumers from even getting to the shops, leading to the negative GDP number for the fourth quarter. A deflationary period for the UK economy appears more likely than an inflationary one in the next few years, assuming that global commodity prices do not continue to rise at the same rate as in recent months, and UK government bonds should prove a better investment than many currently believe.
This note is intended to give an insight into the thought processes that lie behind our investment views and our investment strategy. They do not necessarily reflect the current investment policy of Kleinwort Benson. This note is intended for information purposes only and does not take into account the investment objective, the financial situation, or the individual needs of any particular person. Investors should obtain independent advice based on their own particular circumstances before making investment decisions
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