Thrifty days are here again

Just when we thought that saving had gone out of fashion for good, along comes a fresh set of numbers on the economy indicating that the British consumer is more than happy to start paring back their debts saving more of their incomes.

The savings ratio – which measures the percentage of disposable income saved rather than spent – dipped into negative territory in 2008. In effect people were spending in excess of their income, presumably because they were finding it tough to pay sharply higher utility bills and food prices.

We have always expected saving to rebound as the downturn bites but the scale of the increase in saving has surprised many economists. In the final quarter of 2008 the savings ratio climbed to 5 per cent – the highest it has been since the end of 2005 – and we can expect further rises in the remainder of 2009. One article I read which sounded plausible argued that millions of homeowners on variable rate mortgages are happy to soak up the benefit of a sharp fall in the monthly costs of servicing their tracker-mortgages and are using the windfall of cheaper mortgages to cut some of their debts and build up some savings balances. But although credit card lending has fallen away, repayments are declining too.

There is an apparent paradox here – how can people be saving more when the rate of interest on most savings accounts is as close to zero as we will get, and when there are expectations of price deflation when prices of many goods and services will start to drop?

The answer lies in the word confidence. The vast majority of people expect to see a huge rise in unemployment over the next year and this job insecurity allied to continued declines in house prices is combining to hit sentiment and prompt us to engage in a new bout of precautionary saving.

We are frequently reminded of the Keynesian ‘paradox of thrift’ where if enough people start saving more at the same time, the result is a reduction on consumer demand and an even deeper recession.

That remains a danger – but the key to whether this becomes a reality is what happens to the level of income. If I save 3 per cent of an annual income of £50,000 then I am spending £48,500. If in the next year I save 6% of an income of £52,000, my total savings rise but my spending still rises to £48,800.

The low level of personal saving is seen as an underlying weakness of UK economy. It tends to make UK growth less sustainable not least because it reflects a tendency to borrow for short term consumption that seems to run deep inside our national DNA.

So we should watch the behaviour of the personal sector savings ratio closely as the recession progresses. But key an eye out too for what is happening to real household income.