Why economic recovery could be more painful for Londoners than other Britons

My column in today’s Times poses a question: might those who live in London face a far rockier economic time of things during the recovery than in the recession itself? It would be a significant reversal on the regional story we’ve experienced between 2008 and now.

For many people who live in London and the South East, the recession was only mild. For some, it was nearly non-existent. Unemployment rose, but hardly by as much as it did in the North East, for instance. Economic output is currently 2.4% higher in London than it was in 2008 – while in the North East it’s 7.3% smaller. The regional disparity is even more glaring when it comes to house prices, which are at record levels in London but still about 20% below their 2007 levels in many other regions of Britain.

We’ve covered this in exhaustive detail in various pieces on Sky News – and will continue to look into the regional gulf (which, at least between London and the rest has rarely been greater) in our coverage of the Autumn Statement and thereafter. However, there is a lot of evidence to suggest that whereas regions outside London have suffered most during the recession, it might well be households in London and the South which suffer most during the recovery.

The explanation comes back to interest rates, which are still at their lowest level since 1694.



At some point, however, interest rates will have to rise. And who will be hit hardest when that happens? We have a pretty good sense of how households across the UK are faring with their debt payments. The chart below shows debt service payments as a percentage of household income across the country. As you can see, thanks to 0.5% interest rates and £375bn of quantitative easing, they are close to the lowest level on record.


In broad terms, the higher the line on the above chart, the tougher the overall conditions for those who owe money. As you can see, debt service payments did get pretty high in 2007 as the credit crunch came in and interest rates charged by banks on their loans were yanked higher. What this chart doesn’t show you, however, is how things compare from region to region. Now, it so happens the Bank of England and its colleagues at NMG conduct an annual survey of households and their financial position, the full dataset for which can be found here [warning: BIG excel file].

With the help of the excellent @resianalyst, using data from the survey I’ve had a look at how different regions compare in terms of their debt-to-income ratios. The results are as follows: in London, the South East and South West, households in the survey have debts equivalent to more than 3.2 times their annual income. But as you get further from London and more northerly, the gearing falls: by the time you hit the North East and Scotland it’s down to below two times incomes.

South East 3.29
South West 3.28
Greater London 3.20
West Midlands 3.06
East Midlands 2.89
East Anglia 2.58
North West 2.45
Yorkshire & Humberside 2.42
Wales 2.22
Scotland 1.94
North East 1.66
Total 2.80

Bear in mind these are figures showing overall indebtedness, as opposed to the monthly payments in the previous chart – and that these are results from a survey rather than solid financial numbers. But they seem to support the idea that households in London and the South are far more indebted than those elsewhere in the country. While their incomes may have increased more in recent years, so have the necessary mortgages to afford ever-rising house prices in those regions. My point is that it’s London and the South that will be far more exposed in the event of an interest rate increase.

Which begs another question: is the Bank is really going to raise interest rates and put households through this kind of pain? After all, it has calculated itself that if rates were back up to 4.5% the repayment shock (in other words the burden of mortgage costs) will be back up to the same levels it was in the early 1990s, when a quarter of a million homes were repossessed. This is in part down to the fact that banks are charging more, these days, on top of the official Bank rate, and (more so) because the country’s households, as a whole, are so much more indebted than ever before. Here, courtesy of Michael Saunders of Citi, is household debt as a percentage of incomes.


As you can see,  it has come down since the onset of the crisis – but still remains far closer to its peak than to the level it was in the early 2000s. The higher this chart is, the less the Bank will have to change the official borrowing rate in order to provoke an economic reaction from households (after all, in order to elicit a £5,000 interest bill on a £50,000 loan you’d need interest rates of 10%. With a £200,000 loan it would take 2.5% rates to generate the same interest bill).

This is why the Bank may prove reluctant to raise interest rates all that much. However, it also implies that even a small increase in borrowing costs (and we expect the Bank to at least begin thinking about raising rates this time next year) could prove painful for highly-indebted households. And the figures suggest most of them are to be found in London and the South East.