UK household debt as percentage of disposable income fell further to 144.3% in the third quarter of 2012, down from a peak of 174.7% in the first quarter of 2008 and the lowest since 2004. With the average interest rate on outstanding debt also declining, the interest service burden dropped to a new low of 5.7% of income, in data extending back to 1987 – see first chart.

Commentators often claim that consumer spending will remain weak until deleveraging ends. The level of spending, however, is related not to the level of the debt to income ratio but rather its rate of change. A slower fall in debt/income, other things being equal, will be associated with a decline in the saving ratio and higher consumption. So spending could strengthen in 2013 even while deleveraging continues (without assuming a rise in real income).

A pessimistic view is that the debt to income ratio must return to the 100-112% range in operation between the late 1980s and early noughties, before the recent credit bubble. The current ratio remains far above this range, suggesting no slowdown in the pace of decline.

The “equilibrium” level of the ratio, however, cannot be judged simply by reference to history but depends on factors such as the interest service burden, wealth and credit supply.  As noted, the former does not suggest that current debt is “too high”. Nor does wealth: debt as a percentage of the value of housing and financial assets is estimated to have ended 2012 at 18.0%, the lowest since 2002 and close to the average since 1987 – second chart. Credit supply has been pushing down on the debt to income ratio but may improve at the margin in 2013, partly in response to the funding for lending scheme.

The expectation here is that consumption expansion in 2013 will be the fastest since 2007 (i.e. above the 1.3% rise in 2010), reflecting slower deleveraging and a pick-up in real income due to higher employment and a narrower inflation-earnings growth gap.