Some things are so out of character that they really do make you wonder what is going on. For decades, one persistent criticism of the UK economy was that it was too reliant on consumer spending. Add “debt fuelled” to the description and you were well on the way to completing the UK economy bingo card.
Things have changed, and quite dramatically. Warm off the press are the latest monthly gross domestic product (GDP) figures, which showed a 0.1 per cent increase in August and a 0.3 per cent rise in the June-August period, compared to the previous three months.
The Office for National Statistics noted that while overall service-sector output grew by 0.4 per cent in the three months to August, that of consumer-facing services fell by 0.6 per cent, which is quite a contrast.
• UK economy grew 0.3% in three months to August
It is also a bit of a mystery. Many people say to me that they see a lot of conspicuous consumption around — a lot of splashing the cash or cards — with restaurants and bars full and some people spending as if there were no tomorrow. Away from that, though, there is a silent majority who are much more cautious, often because they have to be.
As a result, consumers are no longer driving the economy. Compared to the pre-pandemic final quarter of 2019, consumer spending adjusted for inflation in the second quarter of this year was up by a mere 0.7 per cent, lagging well behind the 5.1 per cent increase in real GDP over that period.
Even worse has been the recent record. Consumer spending over the past three years, comparing the second quarters of 2022 and 2025, is down by 0.1 per cent. Stagnant, in other words.
Nor is the “debt fuelled” label appropriate any more. Debt peaked at 155.8 per cent of household disposable income as long ago as the third quarter of 2008, when the financial crisis was unfolding. In the second quarter of this year, it was down to 117.1 per cent.
The reluctance of UK consumers to spend is attracting the attention of the great and good.
Mohamed El-Erian, former chief economist at the International Monetary Fund and chief executive of fund manager Pimco — and until recently, president of Queens’ College, Cambridge — tweeted a report showing that UK consumer spending in recent years has been the weakest in the G7 (America, Japan, Germany, France, the UK, Italy and Canada). Adjusted for population growth, spending per capita is below pre-pandemic levels, uniquely among G7 countries.
Catherine Mann, an often “hawkish” member of the Bank of England’s monetary policy committee (MPC), devoted a speech to it recently at the Resolution Foundation think tank: “Explaining the Consumption Gap”. The picture, she said, was “sobering”. Consumer spending in aggregate was well below its pre-Covid trend and the saving ratio has risen to a high of 12 per cent in recent quarters.
Mann offered a long and detailed analysis, which mainly boiled down to inflation “scarring” being a significant factor holding back consumer spending.
“The legacy of the inflation surge and price attentiveness continue to weigh on consumption and saving decisions, with a higher saving ratio via precautionary motives being one explanation for the consumption gap,” she said. “Further, high inflation is associated with more volatile inflation, which makes consumption-savings decisions by households more difficult. The research shows that households who are more uncertain about future inflation become more uncertain about their future incomes, which reduces their expected consumption.”
• Consumers ‘scarred’ by persistent inflation, says Catherine Mann
Put more simply, the recent behaviour of UK consumers is a pretty good advertisement for the importance of low and stable inflation. If people (and businesses) spend their time responding to price rises and anticipating further increases, they will hold back.
Mann, who started her career at America’s Federal Reserve Board, summed this up by quoting her former boss, Alan Greenspan. As he put it: “We will be at price stability when households and businesses need not factor expectations of changes in the average level of prices into their decisions.”
High and volatile inflation is one reason why UK consumers are inclined to spend less and save more. There are, I think, three other reasons.
• UK to have highest inflation rate of major economies, IMF says
Though Bank rate has now been cut five times from its recent high of 5.25 per cent, many households are still contending with higher borrowing costs, as they re-fix mortgages originally taken out when interest rates were much lower. The Bank of England estimates that between mid-2025 and mid-2028, 3.6 million households will move onto higher borrowing costs.
Another reason is tax. Economists have tended to look at the fact that, following a long squeeze, real wages have been recovering, with pay in cash terms rising more rapidly than prices. This is not the only factor that determines disposable incomes, however.
The freeze on income tax allowances and thresholds — which began in 2022 and is due to last until 2028, pending a further extension in the November 26 budget — is biting. People are paying more income tax (and national insurance) by stealth, as they move into higher tax brackets and a higher proportion of their income is subject to tax.
This fiscal drag on steroids, the biggest stealth tax increase in history, is understandably holding people back.
• The biggest tax heist (that you may not have even noticed)
Finally, there is the elephant in the room, the November 26 budget itself, which is sowing even more uncertainty, and spending restraint, than the chancellor’s first budget last year.
Rachel Reeves has made it clear that tax rises are on the way because of the Office for Budget Responsibility’s productivity downgrade, among other factors. Every time she does so, it sparks a new round of speculation on where the tax hikes will come.
Treasury sources insist they are not briefing on specific tax measures, but also that they cannot rule anything out for fear of setting off an elimination game in which, to quote Sherlock Holmes: “When you have eliminated the impossible, whatever remains, however improbable, must be the truth.”
Yes, but only up to a point. Reeves has said she will stick to manifesto pledges not to raise the rates of income tax, employee national insurance, VAT and corporation tax. She has leaned heavily against a wealth tax. Small wonder that people are speculating on whatever remains, however improbable.
Some of the factors holding back consumer spending will start to fade: this week’s inflation figure, widely expected to be 4 per cent, should represent the peak; and budget uncertainty should last only until the budget. Consumer caution will, though, take a while to lift.
PS
People have been responding enthusiastically to my call for budget ideas. I haven’t known anything like it since my last Christmas quiz. It even exceeds my pandemic calls for jokes to cheer us up.
One popular idea, though I suspect it would be unpopular with consumers, concerns VAT. Mike Taylor recalls buying his first SLR camera in 1970 for £69 and 10 shillings (£69.50 for younger readers) — a lot of money. The higher price partly reflected the fact that in those pre-VAT days, the camera attracted a 55 per cent rate of purchase tax.
So why not, he says, “introduce a high rate of, say, 40 per cent on luxury items such as phones, watches and jewellery? An added bonus is that few of these products are made in the UK.”
Philip Rackley is singing from the same hymn sheet, and has helpfully provided a list of things that he says should be subject to his somewhat lower 25 per cent “luxury” VAT rate. It includes handbags and watches over £2,000; expensive cars over £100,000; trainers selling for more than £100, smart phones for more than £1,000, and nail bars. Oh yes, and tattoos. So just in case the chancellor is reading, and you want to get inked, do so before November 26. I certainly will.
Another variant is provided by Chris Langford. In his case, basic products would still be subject to 20 per cent VAT. Anybody happy with a Fiat 500 — and why not? — would pay that amount of VAT, while an Aston Martin Vantage would command a much higher rate, on the grounds that anybody who can afford to pay nearly £200,000 for a car can shell out a bit more VAT.
There is nothing new under the sun and there was a luxury rate of VAT in the 1970s, shortly after the UK’s accession to the European Economic Community. Introduced at a 25 per cent rate on products such as electrical appliances, boats, aircraft, furs and jewellery, it settled at 12.5 per cent, alongside an 8 per cent standard rate. Both were replaced by a 15 per cent rate by Geoffrey Howe in 1979. Two other Tory chancellors, Norman Lamont and George Osborne, lifted VAT to its current 20 per cent.
david.smith@sunday-times.co.uk