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JANUARY 12, 2004
Britain: Higher Rates, But Consumers Will Cope In November, the Bank of England began what is expected to be a series of interest-rate hikes. The question for 2004: With households so heavily indebted, will higher rates turn the consumer spending boom of recent years into a bust, sending the economy into a recession? The resilience of consumer spending, fueled by a teeming housing market, low interest rates, and tax cuts, was a driving force in the economy in 2003. That strength helped to offset the downdrafts from a sagging stock market, the malaise in manufacturing, and geopolitical uncertainty. 
To be sure, consumer spending is likely to slow in the coming year from the 2003 pace of about 2.3%, down from 3.6% in 2002. The housing-market boom is already cooling off. House prices, which soared 25% in 2002, rose about 15% in 2003, and large mortgage lenders expect a gain of 8% to 9% in 2004. Plus, the impact of past tax cuts is waning, and the BOE will be raising interest rates.But will higher rates spell disaster for British consumers? Not likely, says economist Melanie Baker in Morgan Stanley's London office. She argues that the BOE would have to lift its base rate from 3.75% currently to near 8% before the debt-service burden begins to take an unmanageable slice out of household income. That's unrealistic. With inflation now below its 2% target, and with the BOE already concerned about the potential downside implications of heavy debt, the monetary authorities will most likely move cautiously. Including November's quarter-point hike, analysts expect rates to rise about a percentage point in 2004. To a large extent, the higher volume of household debt is a natural result of the trend toward greater homeownership, the rise in household assets, and the permanent reduction in interest rates in recent years resulting from a more credible system of monetary policy. Moreover, exports and capital spending are expected to contribute more to growth in 2004, even as consumer spending slows. With overall growth projected at 2.5% to 3%, gains in jobs and incomes will help to keep consumers afloat.  By James C. Cooper & Kathleen Madigan Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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