The cautious UK consumer

A personal view from Debapratim De, Deloitte’s Chief Economist in the UK.

The cautious UK consumer

It is more than four years since Russia's invasion of Ukraine and the subsequent inflation shock. But consumer spending is yet to stage a broad-based recovery. Household consumption, which accounts for more than two-thirds of GDP, has flatlined over the period, contributing to the UK's sub-par economic performance.

By some measures, consumption has not recovered since the COVID-19 pandemic. The total volume of retail goods and services sold today is around the same level as in 2019 (see chart of the week below). Consumers are spending more than they were – retail sales are up by around 30% in value, but significantly higher prices mean they are getting a lot less for their money.

Persistently high inflation is the primary reason for this weakness. Inflation may be well below its post-Russian-invasion peak but it has averaged 5.3% since 2022, more than double its pre-pandemic norm. This enduring 'sticker shock' has cast a long shadow on demand.

A strong post-pandemic labour market has supported consumers through this period. Wages have been rising at a faster pace than prices for almost three years. As a result, household disposable incomes and spending power have recovered for many.

But several factors continue to weigh on consumption. One of them is the lagged pass through of higher interest rates to household mortgage payments, which is still underway. The Bank of England estimates that over five million households will refinance their mortgages onto higher interest rate deals by the end of 2028.

Higher interest rates also incentivise savings while discouraging credit-supported spend. The household savings ratio, the proportion of disposable income households save, has averaged around 10% since the start of 2024, around double the rate that prevailed before the pandemic.

Responding to a Bank of England survey last year about why they were saving more, over 20% of consumers pointed to higher interest rates. However, the main reason, stated by 36% of respondents, was rebuilding savings for emergencies.

Consumers are likely scarred by recent shocks. Elevated uncertainty over the impact of geopolitics on energy markets and trade, and speculation over domestic politics and taxation have fanned worries about the economy and depressed sentiment.

The headline measure of consumer confidence remains well below its historical average. Interestingly, it is confidence in the wider economy that is really troubling consumers, while sentiment about their own personal financial situation is close to its long-term average.

Higher energy prices, due to the war in Iran, mean rising inflation is set to eclipse wage growth in the second half of this year. Although this squeeze on real incomes is expected to be short-lived (inflation should peak in autumn before falling gradually through 2027), consumer confidence will likely remain subdued. Any shocks, whether in external conflicts or to the domestic economy, will dampen sentiment further.

The good news is that precautionary savings have reduced household indebtedness to around 75% of GDP now, down from 90% in 2020 and well below the peak of 100% in 2009. Recent events have pushed back a broad-based recovery in consumer spending. When it does materialise, it will be bolstered by stronger household balance sheets.