Cost of living pressures to drive significant rise in UK credit card borrowing

Demand for credit from UK households is expected to rise this year as cost of living pressures bite, according to the latest EY ITEM Club UK Bank Lending Forecast, which predicts consumer borrowing will grow to a five-year high of 7.9% in 2022 (equivalent to almost £16bn in net terms).

This is a trajectory reversal of the past couple of years when consumer credit fell by 12% during the pandemic (over 2020-21) and reflects the expectation that consumers will increasingly turn to credit, and especially credit cards, to fund spending and cover bills.

The EY ITEM Club says inflationary pressures, exacerbated by the war in Ukraine, will prompt a significant rise in credit card lending. However, the related price increases of essential goods may force some households to cut spending on discretionary purchases and big-ticket items, creating pockets of suppressed demand for unsecured loans.

The rising interest rates and falling real incomes predicted for 2022 are also expected to reduce demand for other forms of lending. Mortgage lending growth, which stood at 4.3% in 2021, is forecast to fall to 3.8% in 2022 and 3.3% in 2023. At the same time, increased uncertainty and supply chain disruption may depress business investment, with knock-on consequences for business lending.

Anna Anthony, UK Financial Services Managing Partner at EY, comments: “Households are already feeling the cost of living squeeze and unfortunately this is set to worsen over the coming months, with inflation set to hit a 40-year high.

“If there are silver linings to be found both for consumers and for the firms financing lending activity, it’s that interest rates currently remain historically low and overall debt relative to income is also fairly low.

“The current economic pressures, exacerbated by geopolitics, are likely to weigh on appetites for most forms of bank lending, with the exception of credit card borrowing as people rely more on credit to finance essential spending. Banks though remain well capitalised and committed to helping consumers and businesses through this period of challenge, while also maintaining their focus on new regulatory requirements, sustainability pledges and the digital transformation agenda.

“The industry will also be focused, post-Brexit, on continuing to forge new international relationships and deals, ensuring UK financial services continues to maintain its leading role on the global stage.”

Consumer credit set to climb 7.9% this year as credit card borrowing spikes

The recovery in unsecured lending so far this year has mainly been driven by a rise in credit card borrowing. Net lending via credit cards reached £1.5bn in February, more than three times higher than the average of the previous six months and the most since Bank of England records began in 1993.

Annual growth in credit card lending (Feb 2021 – Feb 2022) was 9.4%, a five-year high. This trend is set to continue as increasing numbers of people use credit cards to pay bills and cover essential spend.

Growth in other forms of unsecured lending, such as personal loans, has been more subdued, with a rise of 2.4% year-on-year in February this year. The EY ITEM Club says this may reflect consumers forgoing big-ticket purchases in order to ensure they can pay for essential items and the continued weakness in new car sales.

Private new car registrations in 2021 were 28% below the pre-pandemic 2019 level, as manufacturers scaled back production due to a shortage of semi-conductors and other supply difficulties. This weakness has continued into 2022, and car registrations over January, February and March were 31% down on the same period in 2019.

Mortgage lending growth to ease back as higher rates and higher inflation take effect

Housing market activity was strong in 2021, and mortgage lending grew at a rate of 4.3%, boosted by the stamp duty holiday, record-low mortgage rates and the ‘race for space’ as working from home increased demand for larger, out-of-town properties. In 2021, 1.49m homes were transacted, up from 1.03m in 2020, with transactions the highest since 2007.

While mortgage lending is still forecast to grow over the next couple of years, the EY ITEM Club expects the rate of growth to slow to 3.8% this year and 3.3% next. In cash terms, this equates to net lending of £59.4bn and £53.5bn in 2022 and 2023 respectively.

Slower growth will reflect rising interest rates, growing cost of living pressures and the impact of stretched affordability on housing demand. The average house price in Q4 2021 of almost £270,000 was around 8.75 times average annual earnings, and the average mortgage in Q4 was equivalent to 3.35 times borrowers’ income – the highest ratio since the ONS series began in 1992.

Business lending to grow by 2.8% this year – the same rate it averaged from 2015-2019

Although economic conditions are moving back towards pre-pandemic norms, the EY ITEM Club predicts the business lending outlook for this year and next to be somewhat mixed. Headwinds in the form of higher borrowing costs are expected, with further interest rate rises forecast. In addition, firms face a more uncertain global environment, higher costs for capital goods and a rise in the corporation tax rate from 2023.

According to EY ITEM Club analysis, this may make companies warier about investing and taking on debt. Conversely, continued economic growth, the revival of sectors previously most-affected by COVID-19 restrictions and the incentive to invest offered by the super-deduction tax break could help boost demand for business loans.

Overall, the EY ITEM Club UK Bank Lending Forecast expects net banking lending to UK businesses to grow by 2.8% in 2022 (£13.4bn in cash terms) – the same rate it averaged in the years preceding the pandemic between 2015 and 2019 – and 3.3% next year (£16.2bn).

The EY ITEM Club adds that 2020 and 2021 were abnormal years due to the government-backed loans offered to firms to help ensure financial survival amid lockdowns. In 2020, net business lending rose 8% (£35.5bn) but in 2021 the stock of loans to firms fell 0.3% (negative £1.2bn), the first decline since 2017, as many businesses had less need for emergency sources of finance and were able to repay some of the debt taken out during the early stages of the pandemic as a precautionary measure.

Higher loan losses expected on business and consumer credit lending

The EY ITEM Club forecasts mortgage write-off rates to be 0.01% this year – unchanged from 2019, 2020 and 2021 – and to rise modestly to 0.02% in 2023. However, larger loan losses are expected on the consumer credit and business lending side.

For consumer credit, the squeeze on real household incomes this year and the difficulty some lower-income households may face in paying for essentials means the loan loss ratio is forecast to rise to 1.7% in 2022, having averaged 1.3% from 2015-19 and fallen to 1.2% in 2020. The rate is then expected to fall back to 1.5% next year, as cost of living pressures ease.

For business loans, write-off rates were depressed during the pandemic due to government support (0.2% in 2020); rates averaged 0.4% between 2015-19. Write-off rates rose to a still modest 0.22% in 2021, but the EY ITEM Club says the ratio is likely to rise more meaningfully this year as some businesses struggle to meet repayments and insolvencies increase. Loan losses are forecast to rise to 0.35% and 0.33% this year and next respectively, the former the highest since 2016.