Can consumers dig deep to rescue the economy?
20th November 2022
Despite the gloomy outlook, some well-off households are still spending — and it’s just as well for the economy
In the heart of the north Cumbrian countryside, business is booming. Customers are splashing their cash at the upmarket Farlam Hall, and its rooms are fully booked for New Year’s Eve.
“New Year is always very last-minute, but to be full this far out — and we have been for some time — tells you everything you need to know,” said Antony Penny, executive director of the 12-room hotel.
“People are not worrying too much,” he added.
But then his clientele tend to have little reason to worry about money — despite the admission by chancellor Jeremy Hunt last week that the economy was already in recession, and likely to be stuck there for a year. The vast majority of Farlam Hall’s customers are wealthy, shelling out as much as £550 a night for a luxury stay.
“When customers are on site, they don’t look at the prices on the wine list. If they want to enjoy a very expensive Bordeaux or Burgundy, they will just have it,” said Penny, 56.
Indeed, companies offering luxury products are reporting a boom. Moët Hennessy — with starting prices of about £40 for a bottle of wine — is running out of stock of some of its top vintages amid the rush among richer clients to spend. Philippe Schaus, chief executive, said last week: “As people are coming out of Covid there’s been pent-up demand for luxury, enjoyment and travelling.”
The current upswing, he added, was being described as the “roaring 20s” — evoking memories of the boom between the two world wars.
It seems hard to square this lavish spending with the warning from the Office for Budget Responsibility, announced alongside Hunt’s autumn statement last week, that British households were facing the biggest drop in living standards on record. With inflation expected to peak at about 11 per cent — the highest level in more than 40 years — the independent fiscal watchdog predicted that household disposable incomes would fall by 7 per cent over the two years to 2023 — taking them back to where they were in 2013.
So, with Britain facing a lost decade of income growth, the focus is turning to whether consumers can somehow keep splashing out to cushion the economy from an even deeper downturn. Consumer spending matters as it generates about two-thirds of Britain’s gross domestic product.
Yet a complex picture is emerging. There are signs of a divided Britain. While the high rollers are spending, the Trussell Trust, the charity set up to “stop UK hunger”, warned that the cost of living crisis had created a “tsunami of need” among the less well-off.
In the first half of the financial year, the charity’s food bank network provided more parcels than in a full 12-month period five years ago.
Simon French, chief economist at the investment bank Panmure Gordon, warned that the divide between the rich and poor could widen as the economy started to pull out of recession in the third quarter of next year.
“This is going to be a regressive recovery,” said French.
Those on the lowest incomes are hit most by inflation, spending more of their income, relatively, on essential items such as energy and food, where prices are soaring the most.
While everyone feels the pinch of a higher cost of living, the Resolution Foundation think tank has calculated that the inflation rate for the poorest tenth of households is 12.5 per cent; for the richest, it is 9.6 per cent. This means that as the downturn starts, the wealthiest people are in a stronger position, having also saved relatively more than poorer households during the Covid-19 lockdowns, when people could not go out to bars and restaurants or spend on holidays.
There are now two principal factors that could determine the course of the economy over the next year. The first is whether Russia’s invasion of Ukraine will end, which would bring down the soaring energy and food prices that fuelled much of the rise in inflation to 11.1 per cent in October. The second question concerns how consumers will behave in the coming months and whether their spending will prop up the economy.
“It [consumer spending] will be one of the key things that determines just how deep this recession is,” said Thomas Pugh, economist at the professional services firm RSM.
So what will consumers do? Will they dip into the £150 billion of savings amassed during Covid lockdowns? Or will they start to save more, as typically happens at the onset of recessions, when people worry they might lose their jobs? Alternatively, might they borrow more to continue spending?
Here the Bank of England and the Office for Budget Responsibility provide an illustration of the debate that is raging.
The Bank painted a bleaker outlook for the economy than the OBR when it raised interest rates to 3 per cent two weeks ago. It expects eight quarters of negative growth compared with the OBR’s five quarters, because it is cautious about the extent to which households will run down their savings.
The OBR, however, said last week that it was expecting people “to draw on their savings to cushion the impact of higher prices on their consumption”. It thinks the savings ratio — the amount that households save relative to their income — will collapse to zero next year, compared to the extraordinary high of 24 per cent that it reached during the pandemic in the middle of 2020.
This would represent different behaviour than in previous recessions. For instance, the savings ratio was about 5 per cent the year before the pandemic, but reached 13 per cent in 2010 in the wake of the financial crisis.
Economists are wondering whether this economic slump will indeed be different. “Households have come into a recession with an enormous pile of savings they wouldn’t usually have,” said Pugh, who noted that Bank data had showed a return to precautionary saving.
It is also unusual for a recession to begin with a jobs market where few people — yet — are worrying about their jobs. Data last week showed that unemployment had ticked higher, but at 3.6 per cent, it was still close to historic lows.
Even though the Bank was cautious about whether consumers would dip into their savings, it pointed out that higher-income households are less affected by the rising cost of energy and were more likely to be “maintaining or even increasing spending volumes”.
It cited a survey conducted in early September, that showed that 60 per cent of those in the highest income bracket said they were still buying the same things or more — more than double those in the poorest households.
However, since then, new pressures have started to emerge. Interest rates have risen further — to 3 per cent — and last week the chancellor signalled that he was raising taxes. He is doing this by freezing the earnings thresholds at which income tax bands kick in (known as “fiscal drag”). He is also putting more people in the 45 per cent tax band by lowering the threshold.
So, will the better-off start to feel the pain? Sophie Hale, economist at the Resolution Foundation, reckoned they would still be relatively cushioned. “Higher-income households are able to save more and consume less of their income,” she said. “That means they have more of a buffer to cope with big income shocks and maintain their current standard of living.
“Low-income families, however, tend to spend more of their budgets on essentials like food and fuel, which can’t be easily cut back. This puts more pressure on them to reduce their overall consumption, which has a damaging knock-on effect in the economy.”
Hunt tried to cushion the blow for the poorest households by raising the National Living Wage to £10.42 an hour, a rise of 9.7 per cent, and to put more of the pain on wealthier households. The Resolution Foundation reckons 70 per cent of the new taxes for individuals will be paid by the richest fifth of households. It has calculated that while the poorest fifth will be £350 better off on average, typical households will experience a fall in income of £1,100 in 2027-28, rising to a £4,200 loss for the top decile.
Clive Black, head of consumer research at broker Shore Capital, said that even wealthier households would feel the pinch. On Friday, the latest reading on shopper sentiment in Britain, measured by market research firm GfK, eased only slightly off the record low that it fell to in September.
Black noted that local authorities would be increasing council tax bills, which would knock those with large homes. Better-off households were also likely to be affected by the move to cut the rate at which tax kicks in on dividends from £2,000 to £500 over three years, he added. Higher mortgage rates would also be unavoidable.
“There’s definitely going to be a material compression of consumer spending activity in the next 12 to 18 months. You can’t do all the things in the budget and not have that,” said Black, who acknowledged though that those on the highest incomes would probably still manage to absorb the financial pain.
Anecdotally, consumer-facing businesses report that higher-income customers are still spending.
Judy Joo, 47, founder of chicken restaurant Seoul Bird, said she thought that customers in her Canary Wharf restaurant — probably more likely to be working in finance — in London’s Docklands were less price conscious than those across town in the Westfield shopping centre in Shepherd’s Bush. “In Canary Wharf, there are white-collar and finance executives, whereas in Westfield customers are definitely more price sensitive. People are just having water — they are not having as many drinks,” said Joo.
Graham Hornigold, 47, co-founder of the doughnut-seller Longboys, said he was still getting business from high-end stores such as Harrods and Selfridges, but that the smaller delicatessens he supplies had cut back on their orders.
Harrods reported last month that its sales were on track to recover to pre-pandemic levels, as rich tourists mingled with wealthy Britons to seek out Rolex watches and Dior handbags.
On the outskirts of Truro in Cornwall, riverside gastropub The Heron Inn also reported healthy sales. Nick Hemming, 49, who runs the business with his wife, Amanda, said: “Our spend per head hasn’t dropped and the people coming to us aren’t too concerned about what’s going on [with the cost of living crisis].”
He was speaking after visiting another potential site in Plymouth, where he is thinking of expanding.
Yet in central London, David Moore, 58, the proprietor of Michelin-starred restaurant Pied à Terre, said that trading was “softer” and that it “seems very fragile”. He was focusing on corporate customers who are still spending, he added.
Even those who are enjoying a steady flow of well-off guests offer a note of caution. From his rural idyll in Cumbria, Penny said: “It will be interesting to see how things start to plateau out in 2023.”
Original article here: https://www.thetimes.co.uk/article/can-consumers-dig-deep-to-rescue-the-economy-szzwdm9b5
Author: Jill Treanor, City Editor, The Sunday Times
Managing Director, Head of Research