Bank of England expects the UK Savings Ratio to hit 17% this year from 8.4%

Are you saving enough?

In its latest Money Report, The Bank of England has reported that it believes the UK Savings Ratio could peak to as much as 17% by the end of the year, steeper than following the 2008 Financial Crisis and up from 8.4% for the first quarter of 2020.

An unprecedented rise in savings is expected not only because of the economic shutdown, but also because people are very nervous about the future economy and opportunities to spend are severely limited.

What is the Savings Ratio and why is it important?

The Savings Ratio is the percentage of disposable income that is saved in a household and is an indicator of economic activity. It is also generally considered to show the economic strength of a country with those that have a higher savings ratio likely to be healthier and more able to weather future storms in the economy.

However, as a rule of thumb, savings ratios tend to rise in a period of economic contraction and fall when the economy is booming. In the UK, we saw a 2.2% fall in GDP in the first quarter of 2020 due to the impact of the COVD-19 pandemic.

The UK Savings Ratio for the same period was 8.4%, up from 6.6% for the last quarter of 2019. In comparison, the savings ratio averaged around 5.3% for the whole of 2019 and average around 8% in between 1998 and 2007. 

With the onset of the Financial Crisis in 2008 and the recession that followed afterwards, we saw the Savings Ratio peaking at 13% in the first quarter 2010 as people significantly increased their cash savings in uncertain times. The sharp fall in real GDP in 2008/09 mirrored the sharp rise in the savings ratio.

This is no surprise as our personal spending makes up 63% of GDP with areas such as government spending, investment and exports accounting for far less.

Why does the Savings Ratio rise when the economy is contracting?

In theory, lower interest rates reduce the incentive to save. Is it then counterintuitive to assume that the Savings Ratio will rise? Not necessarily. The interest rate is only one of many factors influencing the decision to save. The main factor is the health of the economy.

When the economy is contracting, the fear of unemployment will naturally cause individuals to be more cautious about borrowing and spending. Rather, paying off debts and increasing savings becomes number one priority in most households. Therefore, people will save more despite the poor return from savings and delay big purchases during economic uncertainty.

We often hear the phrase that banks are “awash with cash”, so it is therefore no surprise then that so many of the big banks are paying virtually (or literally) no interest on their savings accounts. They simply don’t need to.

As a consequence, people take reasonable steps to increase their personal savings and cut back on spending. This rapid rise in private savings can cause a fall in aggregate demand and therefore lower economic growth and output. This is also called the “paradox of thrift”.

Savings Ratio and government intervention

To counteract the impact of the fall in private sector spending, the government needs to borrow and increase its spending. This is exactly what we have seen in the UK as well as worldwide following the Covid-19 pandemic – an unprecedented level of fiscal and monetary stimulus. 

The recent Summer Statement confirmed this with the Chancellor announcing incentives for employers to retain furloughed staff, a temporary VAT cut for the hospitality and tourism sectors and “Eat Out to Help Out” vouchers for diners, to name a few.

The aim of these stimulus measures is to alleviate the fear of unemployment and to promote economic activity, which will define the shape of economic recovery – the famous “will it be either v-shaped, u -shaped recovery”? Only one thing is for sure – this “Great Shutdown” has left the world with many different “unprecedented levels”.

Only a decade ago, we had faced a liquidity crisis. But this also means that we have learnt from that experience.

The “do whatever it takes” approach of governments is a strong indicator of that and equally the investor confidence that led to financial markets recovering much of their losses since the 23rd of March.

If we look at China, its economic recovery has picked up momentum in June as exports and services benefited from government support policies and the reopening of some overseas markets. This might even be enough to record a positive growth in the second quarter of 2020

 Therefore, it seems that the trajectory of the global economic fallout will largely be determined in the final two quarters of 2020. The only thing for sure is that economic stagnation is not an option. 

If you’d like help and advice on your own personal financial situation, why not get in touch to see if you might benefit from speaking to one of our independent Chartered Financial Planners.

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