Economics - Consumer lending a helping hand.

(From Financial Director)

Byline: Dennis Turner.

The future's bright, the future's Brown - or it is if the Chancellor's forecasts for 2004 are taken at face value. Not only is he expecting GDP to grow by at least 3%, up on last year's 2.1%, but he also believes activity will be better balanced, with larger contributions coming from investment and exports. He will not be unduly concerned that he is more upbeat than most economists. He usually is and, more often than not, Brown has been proved right.

Much depends on how the consumer reacts to a marked change in circumstances. Since the mid-1990s, household spending has been the primary driver of growth, increasing at a rate averaging 3.8% a year over the past eight years. In the past two or three years, when other sectors of the economy were struggling, the consumer responded positively to lower interest rates, and spending on the high street, on cars and on houses helped keep growth on track. As Mervyn King, the Governor of the Bank of England has pointed out, the period between 1996 and 2003 is the longest in which consumer spending has grown faster than the economy as a whole since the 1870s.

These growth rates cannot be sustained. Although the widely predicted demise of the consumer was postponed yet again last year, it now looks imminent. The personal sector is coming under increasing pressure from several directions at once. First, private sector earnings growth slowed, from 5% in 2001 to 3% and, more importantly, the gap between increases in pay and increases in prices has all but disappeared. Real wage growth in the private sector is the lowest since 1995. Then, if last April's NIC increase is factored in, it is clear the government is taking a bigger slice of people's pay packets.

Finally, to a greater extent than previously, spending has been dependent on borrowing and households are now estimated to owe the equivalent of 125% of disposable incomes - a record amount. Using the affordability argument to explain this surge in borrowing can be a bit misleading. The fact that repayments account for a smaller proportion of income (on average 8%) than less borrowing did a few years ago does not tell the whole story.

It merely reflects the fact that interest rates have been historically low. Now the cycle has turned, the pain is increasing and there may be more to come.