The Bank of England is right to warn over consumer borrowing – even if the central bank itself has been partly responsible

Britain’s debt timebomb is primed and ready to go off at any time. From never-never spending on credit cards to car loans, from overdrafts to payday loans, there is enough high explosive to devastate the economy for a second time in decade. All that is required is for the fuse to be lit.

The Bank of England is aware of the risks and has been issuing ever-more explicit warnings about debt as the summer has worn on. One of Threadneedle Street’s senior officials told lenders in July that they were dicing with a spiral of complacency by encouraging people to borrow money they might not be able to pay back.

The warnings are fully justified, even if the Bank of England has itself been responsible for the build-up in debt. After all, in the first 313 years of the Bank’s existence, official borrowing costs never once fell below 2%. in 2009 they were cut to 0.5% and left there until shortly after last year’s EU referendum when they were shaved further – this time to 0.25%.

Such low interest rates were deemed necessary in 2009 to prevent what was already the country’s most severe recession since the second world war from turning into a repeat of the Great Depression. The Bank did not envisage keeping rates at record low levels for more than eight years, but that is what has happened. Low interest rates were supposed to encourage people to borrow rather than to save – and that is precisely what has happened. Household debt levels as a share of national output are edging back to the record levels seen in the boom years in the build-up to the financial crisis.

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There have been three stages to this process. In phase one, during the crisis and its immediate aftermath, appetite for debt waned markedly and households took advantage of low interest rates to pay off some of the money they had borrowed during the good times. But with higher oil prices pushing up inflation, wage growth weak and austerity biting, this meant recovery from the downturn was slow.

As a result, the government took steps to encourage banks to lend and people to borrow. The Funding for Lending Scheme provided incentives for lenders to make credit available for mortgages and business loans, while help to buy provided state subsidies for those trying to get a foot on the housing ladder.

The strategy worked – at least in the short term. Activity increased in the housing market, pushing up property prices and generating a feelgood factor among those fortunate enough to be owner-occupiers. With the collapse in oil prices driving inflation down to zero, the years 2013-16 were good years for consumers: their pay packets went further, unemployment was falling and house prices were going up.

Lenders, too, felt more confident and started to offer more attractive deals to borrowers. As Bank of England executive director Alex Brazier noted, the interest rate on a £10,000 personal loan has fallen from 10% in 2010 to 4% today. Credit card companies have been tempting customers with longer periods of 0% interest rates if they switch. Unsecured consumer credit is growing at 10% a year – six times as fast as the economy’s growth rate.

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Stage three of the process began in June last year when the UK voted to leave the EU. Both the Treasury and the Bank expected this to have dire consequences for the economy, with the then chancellor George Osborne predicting a deep recession and a 500,000 increase in unemployment within two years.

The Bank cut interest rates in early August 2016 in the hope of stimulating some extra demand and was surprised at the result. Instead of collapsing, the economy grew more quickly in the second half of 2016 than it had in the first half. Consumers could see that the fall in the value of the pound would push up the cost of imported goods and so decided to buy big-ticket items – often with borrowed money – before prices went up. Spending plans were brought forwards, with the result that strong growth in late 2016 has been followed by weak growth in early 2017. Real incomes have been squeezed because prices have been rising more rapidly than wages. Borrowing has helped to fill the gap.

For now, debt is a problem for some individuals but not for the economy as a whole. Debt servicing costs are much lower than they were before the crisis and the unemployment rate is at its lowest since 1975. Difficulties would only really arise if the Bank felt the need to raise interest rates aggressively or if unemployment were to increase sharply for any reason. Both occurred in the bust of the late 1980s and 1990s, when interest rates were doubled to 15% and unemployment rose above 3 million.

Imagining the circumstances in which the debt timebomb might go off is not all that difficult. There could be a severe run on the pound if the Brexit talks go badly, which would force the Bank of England to raise interest rates despite its concern about the impact on heavily indebted borrowers. A trade war between the US and China could derail what has been a fairly feeble global economic recovery. In truth, it would not take all that much to light what looks to be a fairly short fuse.