Household savings decline in the UK: economic and expenditure factors

Personal Savings

According to the UK Office for National Statistics, household savings declined in the second quarter of 2010 from 5.5% to 3.2%. There are a number of reasons why this decline could have occurred. This paper will examine the different factors that influence household savings rates and will attempt to explain the recent decline in household savings. There are a number of potential influences of savings rates, most especially the state of the economy, which has had a tremendous impact in the past couple of years. Additionally, the prices of consumer goods influences savings rates, and this factor hints that low savings rates a new norm, and that the increase in savings rates in the past couple of years is a blip caused by the poor economy. Once the economy begins to recover, the trend towards low savings rates will be restored.

Factors Influencing Household Savings

There are several factors that contribute to household savings rates. The general state of the economy is one significant factor that must be explored. In 2008, before the economy went bust, the savings rate in the UK was 1.7%. This was the lowest savings rate in forty years, well below the historic average of 7.6% annually (BBC, 2010). By the second quarter of 2010 this had increased to 5.6%. The cause of the uptick was generally considered to be that difficult economic times, and especially layoffs, had convinced Britons to save more of their earnings. Borrowers paid down £7 billion in mortgage equity in Q2 2010, in contrast to economic boom times when consumers were taking out additional mortgages. The fear of losing one's income and of having borrowed too much stimulated the large increase in savings rates over the course of the downturn (Stewart, 2009).

That this trend has now reversed for the third quarter of 2010 could imply that the economic outlook is improving. However, economic growth in the third quarter was slow, at just 0.8% (Marketwatch, 2010). It could be, however, that is was merely the perception of higher growth and a recovery economy that drove down the savings rate -- if savings was driven by pessimism then all it would take is optimism to reduce savings rates, not actually economic improvement.

Shifts in household expenditure can also explain differences in household savings rates. In 1970, food and non-alcoholic beverages represented the largest spending categories for British consumers. By 2008, housing, water and fuel were the largest spending categories. Given that it is a reasonable assumption British people are not eating less, this implies that those three categories of spending have seen abnormal rises in importance. Expenditure on these other goods and services has risen rapidly. This will impact savings rates because as other expenses increase to take up more of consumers' budgets, this may indicate that less money is available for savings (BBC, 2010).

There are also macroeconomic factors that may contribute to lower savings rates. Inflation erodes the ability of consumers to save when their wages do not increase. The Retail Prices Index increased 4.6% in September, indicating that there is some inflation in the British economy. For those on social services, payments were reduced as the result of adjustments to the payout formula. With only minimal job growth in the quarter (9000 new jobs), wages are unlikely to have risen significantly. Overall, this could have resulted in less money among consumers for savings (BBC, 2010, 2).

Interest rates are another factor. The returns on savings are low, so that consumers are unlikely to save anything beyond what they feel they need in their nest egg or rainy day fund. Current rates are savings account are not sufficient to cover inflation, so there is no economic motivation for consumers to save beyond basic security. There remains stock market turmoil amid the various crises around Europe, so markets provide an uncertain mechanism with respect to savings as well. Ultimately for consumers to save they need financial incentive and in the current financial markets that is not forthcoming.

The Trend

I expect the trend towards declining savings to continue. In general, recent years have demonstrated that savings rates are overall heading down. The cost of many consumer staples has increased beyond the rates of inflation or wage growth, and this has led to an erosion of consumer capacity to save. This trend can be seen not only in Britain but in the U.S., Japan and other developed nations as well. Consumers are turning increasingly to credit to fuel their lifestyles, and this is causing significant long-term declines in savings rates.

There is no reason to think that this trend will not continue. There are reasonable, rational reasons why savings rates have increased over the past two years. Fear over the economy lead consumers to better manage their personal debt levels, and to build up savings as a hedge against potential unemployment. However, the cost increases that are the underlying cause of the long-term savings rate decrease have not abated. There are already inflationary pressures in the UK, certainly in relation to the overall economic outlook. Consumers may also have enough money saved after two years of limiting spending. Consumer optimism may be increasing as well, with the sense that the economy is going to improve soon, or at least will not get any worse.

The reduction in savings rates in the third quarter of 2010 may have been temporary, and not indicative of any long-term trend. However, the long-term trend is still for a decline in savings rates. Only economic crisis was able to increase savings rates and with the worst of the crisis now over, it is not unreasonable for the long-term trend towards low savings rates to continue. This is especially likely given the fact that prices are increasing faster than wages and faster than interest rates. There is little incentive to save, as inflation erodes the value of savings at current savings account interest rates. Instead, consumers are motivated to put their money to better use, which for them means purchasing the goods that they want and taking advantage of a newly-soft housing market in order to upgrade their homes. It is for these reasons that I believe the overall trend towards lower savings rates will continue, even if the current decrease does not hold over the long-term. As soon as consumers believe that the economy is set to improve, they will start spending again and this will reduce the savings rate again.

Only a renewal of economic crisis, perhaps spurred by the euro debacle, could undermine the long-term trend. Britons are most likely tired of saving, and are therefore ready to spend again and I believe that they will do so in the near future, if they are not doing so already.

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