Debt-driven recovery ‘unsustainable’ without investment

Economists have branded the UK’s economic rebound as “lopsided” as it has been driven almost exclusively by consumer spending and housing, warning that until rising business confidence is matched by a revival in investment and exports the upturn will not be sustainable.

A report published by accountancy giant Ernst & Young’s Item Club states with GDP now projected to grow by 2.7 per cent in 2014 followed by a forecast 2.4 per cent rise in 2015, “it’s easy to assume that good times are back” but that “the reality is more complex”.

The economists argue that to-date the upturn has been driven almost exclusively by consumer and housing markets - in turn funded by a decrease in savings and corresponding rise in the UK debt-to-income ratio - which together accounted for the vast majority of the growth seen in 2013.

Article continues after advert

Consumers have spent more as job security has improved but this has seen the UK savings ratio fall from 8 per cent immediately following the crisis to around 5 per cent, ending the fall in the debt ratio seen in 2012-2013.

In contrast, business investment detracted from growth in 2013 while net exports made barely any contribution, they add.

With real wages still under pressure, a continued rise in consumer spending would imply a further fall in the savings ratio, which would in turn lead to a renewed rise in debt as a proportion of income. The economists say this points to a need for greater business investment to fuel the next phase of growth.

Alongside the bias towards the consumer, a further imbalance in the recovery is that real wages are continuing decline despite rising employment and the long-awaited fall in inflation, the report states.

The continued slide in real wages from 3.2 per cent to 1 per cent is a “weak spot” in the recovery, the economists say, adding they do not expect average earnings increases to catch up with inflation until the second half of 2014.

Peter Spence, senior economic adviser to the Item Club, said: “This situation poses a dilemma for the Bank of England’s Monetary Policy Committee as it gauges when to raise interest rates.

“With employment rising but real wages falling, the unemployment rate alone is too blunt a measure. Instead, the MPC must hold interest rates steady until real wages and business investment are rising. Otherwise it risks aborting the recovery before it reaches escape velocity.”