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Squeezed UK Household hit as cost of personal loan rate doubles

Written by Edgenie (Original Source from The Guardian)
Last Updated: August 4, 2023 • 5 min read

Summary:

  • UK personal loan rates have doubled from 3.3% to 6.6% in just over 18 months, leading to higher borrowing costs for households.
  • As a consequence of the rise, new customers are having to pay an extra £267 in interest over a 36-month period for the same loan amount.
  • The average credit card debt per household increased from £1,938 in May 2021 to £2,350 in May 2023, with the average interest rate reaching a record high of 20.44%.
  • Providers like John Lewis Partnership have significantly increased their credit card rates, from 20.72% to 24.49%, effective from September 30.
  • The Bank of England data shows the average rate on new personal loans was 8.27% in May 2023, while the typical overdraft rate now stands slightly above 21%.

A Level Economics Possible Questions:

  1. Analyse the potential impacts on consumer spending and borrowing behaviour as a result of the doubling of personal loan rates in the UK since December 2021, as outlined in the article.
  2. Evaluate the implications of increased credit card debt among UK households for the wider economy. Use the information provided in the article as context for your answer.
  3. Discuss how the Bank of England's cycle of 13 consecutive interest rate rises, as mentioned in the article, might have influenced the recent increase in credit card and personal loan rates.
  4. Explain the potential role of financial institutions like Sainsbury's Bank in contributing to changes in the borrowing landscape in the UK, as detailed in the article.
  5. Evaluate the potential economic consequences of higher interest rates on different sectors of the UK economy, considering the specific example of increased loan rates mentioned in the article.

Answers:

  1. The doubling of personal loan rates in the UK since December 2021 is likely to significantly impact consumer spending and borrowing behaviour. With higher interest rates, borrowing becomes more expensive, reducing the attractiveness of loans for consumers. This could lead to a decrease in consumer spending, especially on big-ticket items that are often financed through loans, such as cars or home improvements. Moreover, higher interest rates could discourage people from taking out loans, leading to a decrease in consumer indebtedness.
  2. The increase in credit card debt among UK households could have various implications for the wider economy. High levels of household debt can reduce consumer spending, as more income must be allocated to debt servicing. This could slow economic growth, as consumer spending is a major component of GDP. Moreover, if households are unable to manage their debt and default on their payments, this could lead to financial instability, with potential negative consequences for the banking sector and the broader economy.
  3. The Bank of England's cycle of 13 consecutive interest rate rises could have influenced the recent increase in credit card and personal loan rates by making borrowing more expensive for financial institutions. In response, these institutions might have raised their own lending rates to maintain their profit margins. Additionally, the central bank's interest rate hikes signal an expectation of higher inflation, which could lead banks to raise their interest rates to protect the real value of the money they lend.
  4. Financial institutions like Sainsbury's Bank could have played a role in changing the borrowing landscape in the UK by adjusting their loan rates in response to changes in the broader economic and financial environment. As mentioned in the article, Sainsbury's Bank has doubled its best-buy rate for a £5,000 personal loan since December 2021. This reflects the bank's response to factors such as the Bank of England's interest rate hikes and potentially higher default risk among borrowers due to the economic impacts of the cost of living crisis.
  5. The potential economic consequences of higher interest rates on different sectors of the UK economy could be varied. For consumers, as the cost of borrowing increases, spending might decrease, particularly for goods and services that are typically financed through credit. This could negatively affect sectors such as retail and auto sales. For businesses, higher borrowing costs could discourage investment, potentially slowing down economic growth. However, for the financial sector, higher interest rates could mean higher income from interest payments, boosting profits for banks and other lending institutions.

Possible A Level Economics 25 Marker Question

Evaluate the potential economic impacts on UK households and the wider economy due to the significant increase in personal loan and credit card interest rates, as discussed in the article. Consider factors such as consumer spending, debt levels, and overall economic growth in your answer.

UK economy 'close to stalling' in July as high interest rates hit firms

Summary:

  • The pound has experienced its longest sequence of daily drops since the onset of the Covid-19 pandemic, due to speculation that a faltering economy will restrict further rises in UK interest rates.
  • The UK economy nearly stagnated in July, causing sterling to depreciate for the seventh consecutive day against the US dollar, the worst run since March 2020.
  • The decline reflects market expectations that the Bank of England will not need to raise borrowing costs beyond 6% from the current 5% to control inflation.
  • Despite expectations of a 0.25 percentage point rate increase in the upcoming monetary policy committee meeting, the pound has continued to fall against the dollar, reaching $1.281.
  • The purchasing managers' index (PMI) supported these views, with output declining from 52.8 in June to 50.7 in July, suggesting that the economy is barely growing; inflation in the private sector has also been at its lowest in over two years.

A Level Economics Possible Questions:

  1. Explain the impact of the weakening UK economy on the value of the pound and its implications for interest rates.
  2. Discuss the relationship between interest rates and currency value, using the case of the UK and the recent depreciation of sterling.
  3. Analyse the Purchasing Managers' Index (PMI) data and explain its role as an economic indicator in the context of the UK's current economic situation.
  4. How might a decline in the value of the pound impact UK's import and export markets? Consider the concepts of elasticity and terms of trade in your answer.
  5. Evaluate the potential impact of the Bank of England's expected interest rate increase on the UK economy, considering both short-term and long-term consequences.

Answers:

  1. The weakening UK economy can lead to a depreciation of the pound as it reduces investor confidence, leading to lower demand for the currency. This can also imply that the economy is not robust enough to handle higher interest rates, which could lead to slower growth or a contraction, so the Bank of England may limit further increases in interest rates.
  2. Interest rates and currency value are interconnected. Higher interest rates typically support a currency's value as they offer investors a higher yield, making the currency more attractive. In the recent case of the UK, despite the Bank of England raising interest rates, the pound has depreciated due to concerns over the health of the UK economy.
  3. The Purchasing Managers' Index (PMI) is a measure of the economic health of the manufacturing sector. It provides information about current and future business conditions to company decision-makers, analysts, and investors. In the UK's current situation, the fall in the PMI indicates a slowing economy, which is barely growing.
  4. A decline in the value of the pound can make UK exports cheaper and more attractive to foreign buyers, potentially leading to an increase in export volume. However, it also makes imports more expensive, which can lead to inflation if the increase in import costs is passed onto consumers. The overall impact on the trade balance would depend on the price elasticity of demand for UK's imports and exports.
  5. The Bank of England's expected interest rate increase can have both short and long-term impacts on the UK economy. In the short term, it could lead to higher borrowing costs, which could slow down consumer spending and investment, potentially slowing economic growth. However, in the long term, higher interest rates could help control inflation and stabilize the economy, which might be beneficial if the economy is overheating.

Possible A Level Economics 25 Marker Question

Evaluate the potential economic impacts of a weakening currency on a country's economy, with specific reference to the recent depreciation of the pound in the UK. Discuss the implications for interest rates, inflation, trade, and overall economic growth. Provide examples and relevant economic theory in your response.

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