The UK economy has performed better than expected so far this year, and should avoid recession, leading the EY ITEM Club to upgrade its 2023 UK bank lending forecast for households and businesses.
Total loans to households and businesses are expected to rise 1.2% this year (a net increase of £29 billion), improving on February’s forecast which predicted a 0.1% fall (a net decline of £2 billion). Falling inflation, lower-than-expected energy bills and a resilient jobs market mean UK GDP is expected to grow 0.2% in 2023, rather than contracting as previously forecast. This should drive an increase in consumer and business borrowing.
The EY ITEM Club UK Bank Lending Forecast expects net mortgage lending to grow 1.2% in 2023 (up from 0.4% in the February Forecast) as housing market activity picks up. However, mortgage lending growth is still below the 3% averaged in pre-pandemic years (2015-19), in large part due to rising interest rates, reflecting a housing market which is likely to underperform the wider economy.
Unsecured lending is now expected to rise 6.5% in 2023 (up from 4.8% in the February Forecast), and while business lending is still forecast to contract this year (-0.8% net), it improves on the previous forecast of a -3.8% contraction as financial pressures from high inflation and supply frictions ease.
The challenges faced in the US banking market have so far had limited impact on the UK’s highly capitalised lenders, but risks to the downside are present within the forecast. Rising interest rates, growth in impairments and any deterioration to the wider economy could result in a tightening in the supply of credit.
Anna Anthony, UK Financial Services Managing Partner at EY, said “We’re still on the path to economic recovery and many businesses and consumers – particularly the most vulnerable in society – continue to face significant cost-of-living pressures. This cannot be underestimated, and appropriate support must still be provided, but we are in a more optimistic place than we were a few months ago. The recession that many thought was inevitable is now likely to be avoided and energy prices have fallen, boosting consumer and business sentiment. Despite recent volatility in the global banking sector, the EY ITEM Club has been able to upgrade its growth forecasts for UK bank lending this year, which is positive news.”
“While encouraging, enthusiasm should be measured, in the short-term at least. UK banks continue to face a tough environment with historically low lending growth rates. However, the sector is in a strong capital position and continues to provide ongoing support to customers, businesses and the wider economy. With economic conditions expected to improve over the course of 2023 and into 2024, banks will be able to devote more of their time to other critical areas such as digital innovation, sustainability and governance.”
Mortgage approvals fell significantly in late 2022 and early 2023, falling in January this year to 39,886. This was the lowest level in 14 years (excluding the pandemic period), which reflected an increase in mortgage rates, pressure on household incomes from high inflation and a weak macroeconomic outlook. However, housing market activity has picked-up in the past few months, boosted by an improvement in consumer sentiment, and recent data does not signal significant tightening to lending criteria. The latest Bank of England data reported mortgage approvals climbed to 52,011 in March 2023.
With inflation expected to continue falling back throughout 2023 and with real incomes improving, the EY ITEM Club expects mortgage lending will rise 1.2% this year (a £20bn increase in net terms) and 1.8% in 2024 (£30bn net increase). Further growth of 2.7% is also forecast in 2025 (£46bn net).
The fall in UK energy prices is expected to boost discretionary consumer spending and borrowing, resulting in an improved forecast for unsecured lending growth. However, while the availability of credit remains sufficient, rising interest rates and higher taxes are likely to constrain the amount consumers put on credit cards. Overall, the EY ITEM Club now forecasts unsecured lending to rise 6.5% this year (equating to £13bn net). This represents a rebound from the pandemic 2020-21 period, when consumer credit fell by over 10%. Looking further ahead, 4.9% growth is forecast in 2024 (a rise of £11bn net) and 4.0% in 2025 (£9bn net increase).
The EY ITEM Club expects the stock of corporate bank debt to contract -0.8% in 2023, as higher interest rates dampen businesses’ appetites to borrow. The economic shocks of the last decade or so, combined with the potential for a tightening in lending standards, also present further headwinds. However, with the economy performing better than expected and appetite to lend stable, the forecast has been upgraded from a -3.8% contraction.
Growth in net lending to firms is expected to return in 2024, as the economic recovery gathers momentum, financial pressures from high inflation and supply frictions diminish and sentiment around business investment improves. As a result, EY ITEM Club forecasts net business lending to grow 1.7% in 2024 (a net rise of £9bn) and 3.6% in 2025 (a net increase of £18bn).
The EY ITEM Club predicts write-off rates across all forms of bank lending will rise in 2023, although to a level far lower than they did after the global financial crisis.
Mortgage holders on variable rate products, or who are nearing the end of their fixed rate deals, will see rises in interest payments. However, the relatively healthy financial position of households – the ratio of total debt to incomes is well below historic highs, while many households built up savings during the pandemic – combined with greater leniency by lenders (for instance switching customers to interest-only deals) should mean there isn’t a steep rise in write-offs. Overall, the EY ITEM Club predicts impairments on mortgages to rise to 0.015% this year (up from 0.01% in 2022 but down from the 0.05% forecast in February), before increasing further to just below 0.02% in 2024 and a similar rate in 2025.
Write-off rates on consumer loans are also expected to rise, but the gradually strengthening economy should prevent a sharp rise in impairments. And while interest rates on consumer credit products are typically higher than on mortgages, they tend not to be as sensitive to increases in the Bank Rate. Overall, the EY ITEM Club forecasts write-off rates to rise to 1.5% this year (up from 1.0% in 2022 but down from the 2.7% forecast in February). Rates are then expected to rise to 1.7% in 2024 and 1.6% in 2025. For context, impairments were 5% in 2010.
While corporate insolvencies have increased to above pre-pandemic levels, the write-off rates on lending to businesses has remained historically low, and deleveraging by firms over the last decade means they’re less exposed to higher interest rates than in the past. A forecast rise in impairments, however, is likely to be greater for smaller businesses given their higher exposure to rising debt servicing costs.
Write-off rates on business loans are forecast to increase this year to 0.3% as higher borrowing costs take effect (though this is down from 0.8% forecast in February). This follows a record low of 0.13% in 2022. Write-off rates are then forecast to rise 0.28% in 2024 and 0.24% in 2025.
Dan Cooper, UK Head of Banking and Capital Markets at EY, said “The current market environment is far from easy for consumers, businesses and banks, but economic conditions have improved from just a few months back. While an increase in loan defaults is still looking likely across all lending fronts, the increase is lower than we expected three months ago. UK banks are in a strong capital position, bolstered by the expected rise in total loan growth, and will be able to absorb a higher level of losses. Banks will still need to continue to manage their balance sheets carefully, but they are well placed to deal with whatever challenges lie ahead.”