Warning lights on for the UK economy? Fears grow over surge in unsecured borrowing and easy credit

The prospect of consumers reining in their spending has been highlighted as a major concern ever since Britain voted to leave the European Union 12 months ago - which in turn triggered a sharp drop in the value of the pound.

The consequent rise in inflation, coupled with persistently low wages, was expected to squeeze households budgets, denting consumer spending, the main driver of the UK economy.

However, while data on retail sales has shown consumers have started to tighten their purse strings, there are growing concerns Britons are still spending more than they can afford.

Warnings over unsecured borrowing

While consumer spending staying upbeat - despite the recent spike in inflation - is good economic news, the surge in unsecured borrowing associated with it is not.

Earlier this week, Bank of England (BoE) Governor Mark Carney warned that consumer borrowing was rising at a much quicker rate than incomes, adding banks had loosened credit standards due to "intense competition".

The bank is particularly concerned by the sharp growth in car finance, which allows borrowers to access loans bigger than their salaries.

According to data released this week, finance from car dealerships has grown 20% this year. It has grown by £30bn over the last five years to £58bn.

Meanwhile, credit card borrowing and personal loans have risen by 10% and 7% respectively.

Policymakers at Threadneedle Street are becoming increasingly worried the sharp rate of growth in unsecured borrowing would not be sustainable for much longer. In its half-yearly report, the BoE said it would fast-track its analysis on how large losses in the credit industry would impact Britain's banking sector.

Meanwhile, the Financial Conduct Authority and the Prudential Regulation Authority are both expected to set out guidelines regulating how lenders should treat indebted customers.

Britons dipping further into their pockets

Data released on Thursday by the BoE showed consumer credit rose by £1.7bn, ahead of expectations for a slowdown to £1.4bn and higher than the £1.52bn figure recorded in April.

Growth in unsecured consumer borrowing rose 10.2% year-on-year in the three months to May, higher than from April's 9.7%, and the joint-highest reading since November. Such numbers confirm the fears outlined earlier this week by the central bank.

While the unexpectedly positive data will prompt speculation the economic slowdown experienced in the first quarter might be a thing of the past, it also means households feeling the squeeze are dipping into their savings to continue spending.

"May's UK money and credit figures provide another reason to think that the consumer slowdown shouldn't be too severe," said Ruth Gregory, UK economist at Capital Economics.

"This suggests that households remain confident enough to increase borrowing to help smooth consumption, in the face of the squeeze on their real incomes.

"Of course, this will do nothing to allay policymakers' concerns about the recent rapid increases in unsecured lending and strengthens the case for the Financial Policy Committee to act to address this issue at its next meeting in September."

Samuel Tombs, chief UK, economist at Pantheon Macroeconomics, added: "With CPI inflation running just below 3%, it's clear households have little scope to increase spending.

"Growth in households' financial resources still also is vulnerable to a slowdown in consumer credit; lenders have warned recently that they intend to restrict the supply of unsecured lending."

Will the Bank of England stick or twist?

On Wednesday, BoE Governor Mark Carney admitted hiking interest rates could soon be "necessary" to contrast rising inflation. Carney has repeatedly stated that the bank's main task was to strike the right balance between boosting economic growth and jobs and keeping a lid on inflation.

However, just a few hours earlier, the bank's deputy governor Sir Jon Cunliffe warned raising rates would be a mistake.

"We do have to look at what's happening to domestic inflation pressure, and I think that, on the data we have at the moment, gives us a bit of time to see how this evolves," he said.

Adding to the confusion on Thursday, BoE's chief economist Andy Haldane echoed Carney's stance, insisting the bank should "look seriously" at raising interest rates, in a bid to keep a lid on the rising inflation.

"We need to look seriously at the possibility of raising interest rates to keep the lid on those cost-of-living increases," Haldane told BBC Newsnight.

"For now we are happy with where the rates are, we need to be vigilant for what happens next."

Earlier this month, the BoE voted in favour of holding steady on the 0.25% base rate by a surprisingly close split of five to three, with Michael Saunders and Ian Mccafferty joining long-time dissenter Kirsten Forbes.

Haldane has since hinted he will vote in favour of a rate hike later this year, but warned any increase would be gradual and to a limited extent.