This time last year we were talking about the forthcoming squeeze on incomes.
Inflation was comparatively low, and wage growth was quite strong. But, the latest economic data confirms that today inflation is outstripping nominal wage increases; we have done an economic U-turn.
Import prices are still much higher than they were 18 months ago, meaning inflation will continue above the Bank of England target. In the first and second quarters of 2018, the economy has been slowing. One of the main reasons for this is personal spending, which is the weakest it’s been in over three years and suggests customers are starting to feel the pinch.
Business has been affected too. Businesses are lacking confidence and reducing investment which has also slowed quite markedly. In addition, net trade is yet to make a significant contribution to overall growth.
One thing that’s surprised many is a decline in unemployment. Usually, when businesses are feeling less confident, and customers are cutting back, you would start to see increased unemployment. Instead, unemployment is at multi-decade low and looks set to continue that way.
Economic impact on people
It’s still the case that lower-affluence demographic groups will feel the impact the most, partly because most of their incomes are being spent on goods most exposed to inflationary pressures; such as food and transport costs. Similarly, these groups are also likely to be exposed to fraud and recent fraud trends (seen in the Experian UK&I Fraud Report).
Younger people at the beginning of their working lives will also feel the impact. While we’ve revised our forecast, we still think unemployment is going to increase very gradually. The increase on unemployment won’t be driven by job losses; instead, they’ll be driven by the fact that new entrants into the labour market, such as these younger groups, will find it harder to get jobs. Or more specifically jobs that reflect the skillset they have trained for.
Interest rate rises are now in flight
In August of 2016 the Bank of England cut interest rates down to a record 0.25%. Since then the economy continued to perform above the Bank’s forecasts allowing the Bank to increase rates in November 2017. We are now in the interest climbing scenario that’s been pending for four years. Just last week we heard the Bank of England indicate that the pace of interest rate increases could accelerate if the economy remains on its current track – making the reality of rate rises much more immediate and in the official agenda.
Inflation outstripping wage growth is still going to be the main economic theme as is Brexit uncertainty that is still very much present and stilting investments in growth.
What matters with interest rates is how quickly they continue to climb. Near-term rises rarely matter from an affordability perspective; therefore, vigilance and consideration of interest rate growth over a more extended period should be a factor in any decision.
We will no doubt see some new trends occur in the next 12 months and, as we move closer to Brexit, some of the areas that are currently unclear will come into much clearer focus. What we do know is that we should be considering the impact of a change in any credit risk assessment. Interest rate changes aren’t a new thing – they’ve been talked, and speculated about since 2014. What’s different now is we have a firm commitment. We have an assurance that rates will rise and we need to consider that very point amongst all other economic influences.
As a consequence of this rate rise, a customers’ affordability will likely see an impact.
Even before the actual rises, we can start to see trends in behaviours appear. We are starting to see a surge of applications for fixed-rate mortgages as we predicted, as well as customers and businesses critically reviewing the best strategy for investments which has slowed the volume and value of investments thus far, because of this cautious attitude. House prices are already growing at record levels, but ‘would-be’ home buyers will be considering the viability of buying a house given a higher monthly mortgage cost.
Embedding interest rate rise impact analysis into your risk assessment
Having measures and contingencies in place can help set you in good stead for the day rates do rise again – of which they will. More than ever, this is the time to evaluate the potential impact and ensure impact analysis of rate rises continues to be fed into your risk rules and strategies.
Fluctuations are not uncommon at any stage of the economy. Measuring a customer’s affordability, using robust processes and the most accurate data on their financial commitments, will ensure that your customers can not only pay you back at the start of the loan but will also allow you to monitor their continuing ability to maintain payments in the future. This alternative analysis can therefore not only help you prevent and protect any losses but better support your customers before they struggle.
A typical affordability assessment process will include the capture and retrieval of robust data on the customer’s financial situation including income estimation and verification. It should also calculate disposable income to assess a customer’s ability to repay both today and over the lifetime of the commitment. From here, and from the right level of information, you can set affordable limits and assess both indebtedness and risk.
Experian’s approach to incorporating economics into credit analysis acknowledges and exploits the variation in economic conditions facing different groups of borrowers (identified based on residential location and household type), so enhances the information available and therefore helping you to strengthen, and have more certainty, with any decision.
With Open Bank APIs, resulting from Open Banking, there now presents an opportunity to not only personalise a risk assessment to a much more granular level, but applying economic foresight can give you a more enhanced, forward-looking view, which will, in turn, will help you with a much longer-term stabilised lending criteria to build from.