Are Britain's Scrooges Slowing Recovery?

Normally spendthrift Britons are cutting back on shopping and upping their savings, an austerity that may be harming the economic turnaround
British shoppers on Oxford Street in London are being tempted with big discounts. BEN STANSALL/AFP/Getty Images

Paul Coletti is always on the lookout for a deal. In February the 39-year-old BBC producer took advantage of historically low interest rates to refinance the mortgage on his two-bedroom flat. The accelerated monthly payments are 30% higher than they were before, leaving him less spending money to buy the indie rock albums he collects. But Coletti doesn't mind. "Now is the time to be paying off capital," he says.

Unfortunately for the British economy, there may be a few too many people like Coletti. A new mood of austerity is sweeping the country in the wake of the economic downturn. In recent months, savings rates have more than doubled while spending on big-ticket items such as flat-screen TVs has declined at the fastest rate in decades. What's more, official statistics released Sept. 1 show Britons' $2.4 trillion in personal debt has fallen for the first time since 1993.

The newfound frugality might normally be cause for celebration. For years, economists have felt that British consumers—who have the world's highest debt levels relative to discretionary income (more than one-third higher than Americans')—should rein in spending. Many pointed to the thrifty habits of consumers in France and Germany, where double-digit savings rates and a general aversion to debt limited the excesses of the pre-credit-crunch era.

But that was before the Great Recession. Now policymakers fret that Britain's penny-pinching may do more harm than good. "The lack of spending is holding back the recovery," says Andrew Goodwin, an adviser to the Ernst & Young ITEM club, an economic forecasting group.

Consumer Incentives

The economy is in dire need of a boost. Britain's reliance on the financial industry made it particularly vulnerable when global credit markets collapsed. Second-quarter gross domestic product contracted 5.5% year-on-year, and the jobless rate—usually among the lowest in Europe—is at 7.8% and could soon top 10%. With banks struggling, consumers were expected to come to the rescue. Last year, Prime Minister Gordon Brown cut the value-added sales tax to 15%, from 17.5%, in hopes of persuading citizens to open their wallets. Other incentives, including a successful $495 million cash-for-clunkers program, followed.

But aside from a slight bump in spending at the start of this year, consumers don't appear to be parting with their money. Nonfood sales for June to August, for instance, fell 0.7% year-over-year. And fears that the recession will continue well into 2010 have kept consumer confidence at a 12-month low. "People are scarred from recent experiences," says Alan Smith, managing director at financial adviser Capital Asset Management. "They want to clear debt as quickly as possible."

Total personal borrowing in July—loans, credit cards, and mortgages—fell $1 billion as Britons took advantage of historically low interest rates to rejigger their finances.

The increased saving should help Britain's economy in the long run. With personal indebtedness at 183% of disposable income (vs. U.S. consumers' 134%), the new thriftiness will put household finances on a more even keel. In the near term, "the adjustment to less debt will be severe," says Jamie Dannhauser, economist at London's Lombard Street Research. "But it's exactly what Britain has to do."

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