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There's a Consumer Spending Boom Ahead and it Could be Bigger than the Bank of England Expects

- Consumer spending boom could add 1.0% to GDP says Deutsche
- Bank of England could be underestimating scale of rebound
- U.S. set for record retail sales prints ahead: Wells Fargo

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The UK economy will be boosted by a sizeable jump in consumer spending in 2021 as pent-up savings are unwound according to economists at Deutsche Bank, who also warn that the Bank of England might be underestimating the scale of an impending consumer-lead rebound.

Analysis from Deutsche Bank released this week shows that the scale of the boost to UK economic growth from the spending of savings could amount to 1.0% of GDP, more than twice that expected by the Bank of England. 

An unexpectedly strong economic rebound could in turn drive inflation meaningfully above the Bank of England's 2.0% target.

"For some households, the recent lockdowns and tighter social restrictions have resulted in a significant increase in savings. For others, dependent on full income, the consequence has been an increase in debt," says Sanjay Raja, Economist at Deutsche Bank. "In aggregate terms, however, household savings have ballooned".

Deutsche Bank estimate that total excess savings amount to roughly £160BN heading out of the winter lockdown, which is roughly 12% of UK GDP output.

Consumer savings Deutsche Bank

They cite data that shows household savings have skyrocketed since the pandemic hit the UK, reaching record highs of nearly 30% in Q2 and 15% in Q3.

Based on some conservative assumptions, they think 5% to 10% of the current excess-savings pot will be spent, meaning a 0.5% to 1% boost in GDP can be expected over the next few quarters.

"On average – households are likely to exit the pandemic with healthier balance sheets," says Raja.

Lockdowns aimed at curbing the spread of covid-19 understandably impacted service-orientated industries hardest, meaning consumers were unable to spend as much as they would have liked in restaurants, pubs, cinemas and other socially-orientated activities.

The partial reopening of this sector from April 12 onwards would offer a place for savings to be spent.

"High-contact industries like travel and hospitality have remained exceptionally weak. As economies reopen, household savings, which grew due to limited spending opportunities and high government transfers, will help to fuel a surge in services consumption," says Craig Wright, Chief Economist at Royal Bank of Canada (RBC).

RBC Capital

What does this spending of pent-up savings mean for the economic growth outlook?

"In the very near-term, there is material upside risk to our current household consumption forecasts (and in turn GDP projections) for 2021," says Raja.

The Bank of England said in their latest set of economic forecasts that they anticipate consumers to spend 5% of their excess savings in the next few quarters. The Office for Budget Responsibility (OBR) says their modelling shows that 5% of Covid-19 savings will be spent each year for the next five years.

In an interview with the Observer, the Bank’s governor, Andrew Bailey, recently said there was a chance after being cooped up for so long people would “go for it” once the vaccine programme allowed the economy to reopen.

Bank of England chief economist Andy Haldane said last month that large household Covid savings could see the UK economy benefit from an explosion in consumer spending post-lockdown to help charge a rapid economic recovery.

"We see the Bank of England's estimate of pent-up demand as perhaps too conservative," says Raja.

Deutsche Bank acknowledge that not all households have been able to save during the pandemic, particularly low-income households.

Therefore, any increased spending will not be shared across the population. As an example, a well-off household can only go to the pub so many times in the weekend meaning some savings will be retained into the future.

Consumer savings in advanced economies

Calculating the percentage of savings that will be deployed is therefore important when trying to understand how big the economic rebound will be.

"While the overall savings pot is large, a good portion of it will likely go unspent given the lower marginal propensity to consume among higher income earners," says Raja.

Deutsche Bank have utilised two models to ascertain just how sizeable the post-lockdown spending splurge will be.

One model relies on micro spending and saving data for each income bracket, a second model is based on a recent study from the Institute of Fiscal Studies (IFS) which quantified what the marginal propensity to consume could be as a result of a 'one-off' fiscal windfall.

Under model 1 – their more conservative approach to estimating pent-up demand – their bottom-up analysis shows that 5% of excess savings could be spent over the coming quarters.

Under model 2 – a more lax approach to estimating pent-up demand – roughly 11% of excess savings are spent in the near-term as per the IFS' estimate of the marginal propensity to consume from a financial windfall.

This would translate to just around £15BN (c.0.9% of GDP) in additional private consumption filtering through into the economy.

"As the UK emerges out of its winter lockdown, we expect household consumption to pick up strongly. In fact, we expect this to be the driving force behind the UK's near-term economic bounce," says Raja.

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The return of the consumer is not expected to be unique to the UK as other major developed countries that saw generous government aid prop up the economy during the crisis are also expected to see a consumption-lead economic boom.

Analysis from U.S. commercial lender Wells Fargo shows that bumper retail sales readings are likely in the U.S. over coming months.

"In data going back to the 1940s, U.S. consumer spending has never grown at an annualised percentage rate north of 10% in back-to-back quarters, but our latest forecast update says that is exactly what could be in store for the second and third quarters of this year," says Tim Quinlan, Senior Economist at Wells Fargo Securities, LLC.

Wells Fargo economists are predicting the fastest six-month pace of consumption in at least 70 years.

U.S. households are set to receive another $700 billion over the next six months from the latest round of Covid-19 fiscal relief, which will add to already elevated levels of "excess" personal savings.

Disposable income Wells Fargo

The call comes a day after the U.S. House of Representatives passed a $1.9TRN emergency spending measure designed to mitigate the financial toll of the coronavirus pandemic, putting the United States economy on a path to recovery.

"A combination of a mountain of savings and over a year of forced-thrift among consumers leaves us fairly optimistic for a sizeable snapback in spending this year," says Quinlan.

Consumer confidence is likely to be elevated now that the vaccination programme means the health crisis is firmly in retreat, which will likely add fire to any spending boom.

Wells Fargo forecast the overall level of real personal consumption expenditures surpassing its pre-virus peak (Q4-2019) by the second quarter of this year, with the pace of growth remaining above trend throughout our forecast horizon to 2022.

With spending likely to rocket, the pressure on prices will likely rise.

"The prospect of stronger growth, rising commodity prices and the persistence of aggressive policy support have awakened concerns about inflation pressures building. A jump in inflation rates into the spring will largely reflect base-effects from very low energy prices a year ago, although an acceleration in household demand will also leave underlying price growth trends firming into next year," says RBC's Wright.

Deutsche Bank says the rise in consumption, particularly around services, should also result in some upward price pressures over Q2 and Q3 as pent-up demand flows through into the economy.

Their inflation forecasts are conditioned on a slightly stronger pick up in services prices due in large part to pent-up demand rising over the coming months, which should see headline CPI moving above the Bank's target in the second half of this year.

Their fourth quarter 2021 CPI inflation projection is 2.3% year-on-year.

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The impact of demand on inflation is therefore obvious, but what could be of concern to the Bank of England and other central banks is that it is not just demand that will stoke inflation but supply too.

Half of UK businesses indicate that they experienced supply chain disruption in the past month, according to the March release of the Lloyds Bank Business Barometer.

The report says as a result of supply chain disruptions companies are more likely to raise their prices in the coming year: 46% expect to do so, compared with 27% of firms citing no supply chain issues.

The findings raise concerns that UK inflation rates are likely to rise sharply over coming years, which will likely prompt markets to pull forward the expected date of the first Bank of England interest rate hike.

The report reveals 70% of firms that both import and export have been affected by supply chain problems.

The combination of a supply and demand shock could therefore deliver a rude inflationary boost over coming months.