The smug adage “neither a borrower nor a lender be” has gained in force over the past two months. Those with enough cash squirrelled away to sit out the credit squeeze are in a happy position. Most, though, will be worrying about its impact on mortgage and credit card bills, wondering whether the criticism by George Osborne, shadow chancellor, of “an economy built on debt” carries some truth.

Household debt has trebled to £1,354.6bn in the UK over the past 10 years, rising from 90 per cent of annual household income in 1996 to 145 per cent last year – the highest proportion in the G7. The rapid increase has seen more people running into difficulties – the number of insolvencies has surged and the Council of Mortgage Lenders said in August home repossessions had been rising sharply.

Yet until now, the Bank of England has not seen rising debt levels as a risk to the economy. That is partly because insolvencies and repossessions remain relatively few, well below the numbers seen in the recession of the early 1990s. The Bank also found those most prone to default are on low incomes and therefore have a limited impact on overall consumer spending.

The majority of debt is secured on housing and held by wealthier homeowners whose assets have grown in value much faster than their obligations. Households’ net worth stood at £6,898.6bn at the end of 2006, according to official data.

Nevertheless, many analysts are now worried that the tightening in credit conditions will hit household income hard, as mortgage lenders take a tougher view of risky customers and seek to pass on their own higher funding costs. Subprime borrowers could face dramatically higher repayments, while the swathe of middle-class borrowers about to renew fixed-rate mortgages could find terms have worsened more than expected after the last year’s rises in official interest rates.

A new survey of credit conditions by the Bank suggested this week that such problems had yet to materialise, showing lenders expected to tighten conditions on corporate loans while the supply of secured credit to households would remain unchanged.

The prospects for fixed-rate mortgages may also be less serious than feared, since they are linked to swap rates that have been falling on expectations of an eventual interest rate cut.

“Even with the Northern Rock debacle in the system, financial institutions are insulating households,” said Malcolm Barr, economist at JPMorgan, who expected mortgage terms to worsen significantly only for the riskiest borrowers.

However, Michael Saunders, economist at Citigroup, said the Bank’s survey of lenders with a market share above 1 per cent might not include many of the smaller wholesale lenders who had lent aggressively and driven recent growth in mortgage approvals.

If debt burdens worsen, it will come at a time of increasing fragility in household finances. Average earnings grew just 3.4 per cent in the second quarter, the slowest rate in four years, while the amount of taxes paid has risen sharply. The growing problems of affordability in the housing market have also led to debt being held by a smaller number of households, borrowing a larger amount.

“You don’t need as large a rise in interest rates any more to have a big impact,” said George Buckley, economist at Deutsche Bank. “The whole thing comes at a really bad time for consumers.” Although the recent tightening in monetary policy has been modest compared with the 15 per cent rates at the end of the 1980s, debt service as a proportion of disposable income is at its highest level since 1992.

Ben Broadbent, economist at Goldmans, argued that the economy was better placed to weather a downturn than it had been during the last house price crash. Fewer people have borrowed the full value of their property, and turnover in the housing market is lower, so that fewer would be caught out by a fall in prices.

“I think we’re in for a continued steady rise in defaults and problems on mortgages for the next couple of years, but I don’t think they’ll reach the level they did in the late 1980s,”he said.

However, signs of a slowdown in the housing market are gathering, and many economists are now cutting their forecasts for economic growth in 2008 because they expect consumers to be cutting back spending.

Talk of a recession is confined to scaremongers – but the overriding view seems to be that things are bound to get worse.


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