Brexit and the Hit to U.K.’s Consumer Culture

A nation of shopkeepers is by definition a nation of shoppers. U.K. household spending on goods and services accounts for around 60% of gross domestic product and has kept the show on the road in recent quarters. But it will be a diminished force after the Brexit vote.

The U.K. economy was already lopsided before the June referendum. Household spending grew a robust 2.8% in the first quarter from a year earlier, even as other sectors stagnated. Consumers were buoyed by low unemployment, increased appetite for borrowing and low inflation.

Confidence was fading even before the June 23 vote. A snap poll conducted by GfK after the vote shows the sharpest drop in confidence for 21 years, with declines across all categories, including the outlook for personal finances and the general economy.

Mechanically, the headwinds are already building. One of the biggest is the interplay between wages and inflation. U.K. workers had already endured a six-year squeeze on real wages after the financial crisis. In recent months, real wage growth has been running at about 2%, but only because inflation has been close to zero. The steep fall in sterling will be disruptive: HSBC forecasts inflation rising to 4% in 2017.

Spending also has been helped as precautionary savings have declined. The household savings rate has fallen back to 5.9% of disposable income, similar to the precrisis level. Increased uncertainty may push it back up again, particularly since U.K. consumers remain relatively heavily indebted, with debt at 1.3 times disposable income, according to the Bank of England, down from a peak of 1.5 times but well above levels of the 1980s and 1990s.

There are some mitigating factors. Household spending tends to be more resilient than investment. The effect of Brexit is more diffuse than that of the Lehman collapse, which pushed year-over-year spending down 5% by mid-2009. Other recessionary periods have shown milder contractions. And fiscal policy looks likely not to tighten as expected, perhaps helping consumers. This is one area investors should watch closely, as the debate about the fate of U.K. austerity unfolds.

But the risk is of a deeper dip. Were the Brexit vote to lead to a new crisis in Europe, U.K. consumers won’t be immune. The U.K. economy has been flying on one engine: it is at risk of sputtering.

Write to Richard Barley at richard.barley[a]