Strong UK savings bode well for bonds

Excess savings have been at the centre of heated debates among economists and market participants ever since the pandemic.

Savings ratios are conceptually defined as the percentage of disposable income that households save in a given month. This deceptively simple definition does get trickier once one starts delving into the detail as to what is and what isn’t included in the numbers, pensions being one of those categories that is accounted for differently across countries. But it is fair to say, as we mentioned some quarters ago, that savings ratios trends have shown significant divergence in G7 economies. In the US, savings ratios are now lower than their pre-pandemic levels. In the UK and Europe, they are higher. The reasons behind these divergences might be cultural but are also likely influenced by the energy crisis and Russia’s war in Ukraine.

There is an argument for saying that the more important discussion is how the situation regarding savings has changed compared to pre-Covid days. In other words, what excess savings do consumers have at their disposal thanks to the fiscal transfers and reduced expenditure we saw as the world went into different degrees of lockdown for several months? There is considerable uncertainty when it comes to estimating excess savings, since it requires making an assumption about what the savings path would have been in the absence of Covid. We would be highly suspicious of any analyst claiming they have the definitive answer to this, as even extrapolating a pre-pandemic trend means selecting a timeframe for calculating said trend. The best we can do is look at the problem from different angles and try to get a ballpark direction of travel and number.

Luckily the UK’s Office for National Statistics (ONS) published a report this week that looks exactly at this issue, estimating post-pandemic excess savings in three ways. First, it compares the actual savings ratio with the previous trend (using data from January 2017 to December 2019). Second, it looks at financial accounts to gauge the destination of those excess savings and whether examining any patterns might shed some light on what amount of those savings can be considered truly “excess” savings. And third, the ONS has developed a model of what the savings ratio “should” have been, based on historical relationships between macro variables and comparing the model’s forecast to the actual savings ratio. The analysis covers the well-documented rise in savings in 2020 as Covid hit, and the less well-documented increase in the ratio we have seen since Q2 2022.

The ONS conclusions are interesting. First and perhaps most obvious is that diverging trends in savings ratios between countries go a long way towards explaining different growth dynamics. In the UK and Europe, where households are saving more each month compared to pre-pandemic, consumption has not recovered as strongly as it has in the US, where the opposite has occurred. Second, since Q2 2022 when rate hikes and other cost of living pressures started having a major impact in the UK, nominal total income has increased significantly above the pre-pandemic trend along with wage inflation. Consumption on the other hand has been sluggish, which explains why savings ratios have recently increased again. Third, the choice of financial assets those savings have been directed into does shed some light on what fraction of post-Covid savings look like excess savings. Data shows that the initial jump in savings in 2020 found a home in short term deposits, which have now been partially unwound. Since Q2 2022 the rise in savings has been partly used to pay down debt, most likely reflecting the increase in interest rates. The ONS maintains that savings invested in long term assets, or used to permanently reduce debt, are easier to qualify as excess savings as they are not being kept available for use in day-to-day expenses.

Lastly, the ONS concludes the UK consumer still has a significant amount of excess savings left. The number it arrives at is close to 13% of total annual income, which equates to approximately £230bn. Furthermore, it argues that paying down debt should be included in excess savings. If one consumer keeps £100 of savings and £100 of debt, while another uses their £100 of savings to pay off their £100 of debt, then the former appears in better shape as he or she has more savings than the latter. But this is not really the case. In other words, the ONS argues both sides of the consumer balance sheet should be considered. A good summary of some of these trends can be obtained by looking at UK households’ debt-to-disposable income ratio in the graph below. The ratio had flatlined after falling in the aftermath of the global financial crisis. Post-pandemic it resumed its downward trend thanks to both higher income and the paydown of debt.

From a fixed income perspective this is certainly encouraging. There is conclusive evidence that the UK consumer is far from running out of excess reserves; in fact the ONS argues they aren’t even declining. As fixed income investors, our ideal world is not the same as that of equity investors. We would much rather take the boredom of lower growth, lesser inflationary pressures, and lower leverage along with higher buffers in the form of savings in case of trouble, than excessive growth with more inflation and less of a cushion. We don’t want to sound boring, but in bonds, boring is good.