- UK mortgage lending forecast to grow 4% this year, but slow to just 0.7% in 2023 – the lowest level since 2011
- Demand for consumer credit expected to rise 7.2% this year and 5.1% next as cost-of-living pressures escalate, representing a reversal of the pandemic period when demand fell more than 10%
- Bank-to-business lending forecast to grow 2.2% this year but fall 3.5% (net) in 2023 as UK businesses’ appetite and ability to invest affected by the deteriorating economic outlook and rising interest rates
UK mortgage lending is expected to rise 4% this year, following strong demand in the first half of the year, but slow sharply in 2023 with just 0.7% growth due to rising mortgage rates and falling real household incomes, according to the latest EY ITEM Club Outlook for Financial Services. This would be the lowest rate of mortgage growth since 2011 amid the aftermath of the financial crisis.
As market demand wanes, banks are also expected to tighten their lending criteria as they contend with higher interest rates, a riskier economic outlook and volatility in markets.
On consumer credit, the forecast is for significant growth this year, at a rate of 7.2%, as cost of living and inflationary pressures deepen. This high rate is not expected to be sustained, and as inflation falls back and the squeeze on households’ real incomes eases, the growth rate is predicted to slow to 5.1% in 2023.
While a return to growth for business lending is forecast this year (2.2%), levels remain low by pre-pandemic standards. Looking to 2023, a net fall of 3.5% is forecast as businesses’ appetite and ability to borrow is affected by the deteriorating economic outlook, rising borrowing costs and an overhang of debt from the pandemic.
Anna Anthony, UK Financial Services Managing Partner at EY, comments: “Geopolitics and the worsening economic environment are having a significant impact on households and businesses. While interest rates are still fairly low by historic standards, they are the highest they’ve been in a decade and are set to rise further. This will put further pressure on already-strained finances and will have a knock-on effect on demand for most forms of bank lending next year, as potential homeowners postpone purchases and businesses pause investment.
“Affordability is stretched and mortgage and business lending are likely to slow to a rate similar to that seen post-financial crisis. The key difference now is that tighter regulation and higher solvency levels mean banks are well capitalised and far more able to support customers through this challenging period. Another crucial difference is that many consumers are entering this period with a financial cushion in the form of savings built up during the pandemic, and businesses that took out government-guaranteed loan schemes during COVID-19 remain on fixed rate terms at relatively low interest rates. This all means that consumers and businesses are better positioned than they were over a decade ago, and the banks better able to support them.”
Homeowners keen to lock-in low rate mortgage deals but demand set to fall in 2023 as rates rise
Overall housing market activity has remained fairly buoyant this year, in part as buyers looked to lock-in low rate deals, with mortgage lending forecast to grow 4% during 2022 (£63bn in net terms). However, rising interest and mortgage rates, combined with the growing financial strain on households as real incomes are set for the biggest annual decline since the 1970s, will mean growth will slow significantly. In 2023 mortgage lending is forecast to grow just 0.7% (£11bn) with slightly higher growth of 1.4% forecast in 2024.
Consumer credit set to climb 7.2% this year as cost of living pressures worsen
Demand for consumer credit is expected to rise this year by just over 7% (equating to £14bn in net terms). This is a reversal of the trend in 2020 and 2021, when consumer credit fell by over 10% amid the pandemic. This growth reflects inflationary pressures compelling households to make more use of loans and credit cards to support spending and a recovery in some forms of discretionary spend, such as foreign holidays.
Further growth is still expected in 2023 as cost-of-living pressures continue – forecast at 5.1% (£11bn) – but government action to help mitigate the financial squeeze on households and a gradual fall in inflation will start to ease those pressures. The cap on household energy bills means that CPI inflation is expected to peak at under 11% this autumn, rather than the 14%-15% that had been in prospect prior to the cap. In addition, the cuts in National Insurance Contributions due in November will boost households’ resources. In 2024, lending growth is expected to fall a little further to 4.2% as inflation falls back and there’s a recovery in real household incomes, which reduces the need for credit.
Business loans to fall net 3.5% in 2023 due to deteriorating economic outlook
In contrast to 2021, when many UK businesses focused on paying back pandemic debt, this year has seen a return to growth in borrowing, particularly by large corporates. That said, average growth of 2.4% in the eight months to August was low by pre-pandemic standards, where annual growth averaged 5.2% over 2018 and 2019.
A deterioration in the economic outlook, rising interest rates, inflation in the price of capital goods like machinery and the end of the ‘super deduction’ tax incentive next April are all expected to subdue business lending in the second half of the year, with 2.2% (£2bn) net lending growth forecast for 2022. A weakening economy and higher borrowing costs mean net lending is forecast to fall 3.5% (£-6bn) in 2023.This would be the first decline in six years, but less severe than the average annual fall of 7.2% between 2009 and 2012 during and after the financial crisis.
The forecast beyond next year is for a sluggish recovery in lending, with 0.8% growth expected in 2024. This reflects continued constrained appetite among firms to invest as sentiment is damaged by the series of shocks which have affected the economy over recent weeks and years.
Higher loan losses expected but lower than financial crisis peaks
Recession and higher borrowing costs are likely to push up impairments on all forms of lending. However, the EY ITEM Club does not expected levels to exceed the peaks recorded in the financial crisis, as tighter regulation and savings will help cushion the impact for consumers, while for businesses who took on debt during the pandemic, low interest, fixed rate government-guaranteed loan schemes will help keep repayments manageable.
Impairments on mortgage loans are forecast to rise from 0.02% in 2022 to a nine-year high of 0.05% next year. This remains below the peak of 0.08% reached in 2009. In 2024 it is forecast to fall to 0.04%.
Write-off rates on personal loans and credit cards are predicted to be 1.9% this year, rising to 2.5% next – the highest level since 2012, albeit half the 5% peak reached in 2010. In 2024 write-offs are forecast to fall to 2.2%.
Meanwhile, impairments on business loans are forecast to reach 0.7% in 2023, approaching double the previous year’s 0.4%. But again, this would still be a long way short of rates of 1%-1.5% in the early 2010s. In 2024 impairments are forecast to drop back to 0.4%.
Dan Cooper, UK Head of Banking and Capital Markets at EY, comments: “High inflation and falling real incomes mean it is a worrying time for many UK households and businesses just recovering from the pandemic. UK banks are committed to helping consumers and businesses through this difficult period and are in a strong capital position to do so.
“After years of very low interest rates a rising rate environment will help bank profitability, but there are a number of headwinds the sector is contending with. Low and falling rates of lending growth will clearly affect profit levels, and although not expected to reach post-financial crisis levels, defaults are likely to be significant which means banks will have to manage their balance sheets carefully.”
Mixed outlook for insurers with rising interest rates and weakening economic picture
The EY ITEM Club forecast suggests that insurers face a mixed outlook. Household incomes are set for a sizeable fall, meaning spending on big-ticket (and insurable items) is likely to be weaker. An unsteady housing market will also have negative consequences for insurance, while the recent fall in bond prices – which pushed up yields – has not been helpful for insurers’ balance sheets. On a more positive note, rising interest rates and the prospect of falling inflation over next year will provide some respite for the sector.
For general insurers, weaker consumer demand, exacerbated by cost of living pressures, and the risk of a property market downturn, affecting housing transactions and new car sales, will affect profitability. Overall, non-life premium income is forecast to grow 4.1% this year, slowing to 1.5% in 2023.
For the life sector, the rise in long-term interest rates over the last six months, including the rise in UK yields since late September following the mini-Budget, is good news in some respects, as it boosts the income stream from new bond purchases. But even after the recent calming in market volatility, the value of bonds has fallen, to the detriment of balance sheets.
While cost of living pressures may cause some consumers to cancel or lower their life insurance coverage, demographic developments should provide some offset, supporting flows of money leaving defined benefit schemes and moving into individual pensions and pensions drawdown products. The UK population aged 60 or older is projected by the ONS to grow from 16.7m in 2021 to 19.6m by the end of this decade.
The sector has also been bolstered by continued growth in workplace pensions. The latest data from the ONS show the workplace pension participation rate standing at 79% (22.6mn employees) in April 2021, up slightly from 78% in 2020. Life premiums are forecast to rise 5% this year, but contract 1% in 2023 as inflation and economic uncertainty affect pricing and demand. Excluding the pandemic period, this would be the first decline in premiums since 2016.
Value of UK AUM is set to fall this year, with a modest reversal expected in 2023
A difficult macroeconomic environment, reflecting geopolitical uncertainty, high inflation and moves by many central banks to tighten monetary policy, has been bad news for asset values in 2022. Added to these issues has been the significant decline in UK gilt prices following September’s mini-Budget. Although the value of overseas assets held in UK funds has been boosted by a relatively weak pound, UK AUM is forecast to fall 9.9% this year to £1.58t, representing the biggest annual decline since 2008.
The near-term outlook for asset prices is poor and it is unlikely there will be further declines in sterling – which would bolster the sterling value of overseas assets held by UK AUM – given the currency’s already depressed level. Further, the financial pressure faced by households will cut scope for discretionary saving, while recent market volatility could deter their appetite to invest, which will reduce inflows into funds. As inflation falls back during 2023 and cost of living pressures start to ease, central banks may rein back their hawkishness, supporting asset values, while households should find themselves in a better position to save. If this bears out, the decline in AUM values should prove temporary. AUM is forecast to rise only 2.5% next year, but then bounce back to 6.4% in 2024, leaving AUM at £1.72t.
Anna Anthony concludes: “Despite the weakening and uncertain economic picture, UK financial services firms will continue to provide strong support to consumers, businesses and the wider economy, just as it did through the pandemic. While the sector continues to face challenges, it remains a leading force on the world stage as it forges its post-Brexit path, with sustainability, digital innovation and strong governance at its heart.”