Why debt dynamics show promise for UK economy

By Sebastian Burnside, Chief Economist, NatWest Group

Debt is often framed as a risk rather than an opportunity when assessing an economy. A long history of connections with financial crises brings negative connotations.

But debt doesn’t have to be seen purely as a negative. It is also an enabler with the potential to activate investment and help promote economic growth.

Currently, UK household debt is in good order and companies are in solid financial shape, having deleveraged over recent years. Private sector and household debt has fallen from 247% of GDP in 2009 to 157% today, according to the International Monetary Fund.

Public sector debt, on the other hand, has followed a contrary trend. The global financial crisis (GFC), Covid pandemic and an energy crisis have pushed public sector debt upwards. It was around 35% of GDP in 2007, and is forecast by the Office for Budget Responsibility to peak at 97% in 2028.

We have basically seen a shift in where UK debt sits. It was weighted more towards the private sector before the GFC, but now more of it sits in the public sector.

From an economic growth perspective, while this still presents challenges, it is far from the worst-case scenario. Governments engaged in debt and deficit reduction are likely to weigh on growth by taxing more and spending less. But that needs to be balanced against the alternative of households retrenching or corporates investing less to strengthen their balance sheets, which could weigh on growth more heavily.

Governments also have a lot more tools to help them deal with their debt issues. These range from deploying quantitative easing when market conditions get challenging, to maintaining supportive tax treatments for investors – something the last two government Budgets have maintained in the UK.

UK households have dealt with large interest rate rises in recent years – the Bank of England raised its Bank Rate from 0.1% in 2021 to a peak of 5.25% in August 2023, its highest level since 2008. It has since fallen to 3.75%.

This had a significant impact on the cost of secured debt, and we have seen much less household borrowing as a result.

Alongside this, various measures have been introduced by regulators since the GFC to prevent people from amassing too much debt, such as 2014’s Mortgage Market Review which tightened controls for mortgages.

So we now have a household sector that is under leveraged – you would have to go back to 2002 to find a time when the household debt-to-income ratio was lower than it is today.

This means there is great potential for people to start borrowing more and boosting the economy. And there are wider opportunities for them to do so. Over the last five-to-10 years we have seen increases in both peer-to-peer lending – where individuals lend to others through online platforms – and ‘buy now, pay later’ schemes.

This adds up to a UK consumer with the financial firepower to borrow more, buy more, and fuel economic growth.

Overall, UK companies are carrying relatively modest levels of debt by historical standards. In the years following the GFC, banks were more cautious about lending to non-financial corporates, encouraging businesses to repair balance sheets, improve cash flow resilience and reduce leverage. According to the International Monetary Fund, UK non-financial corporate debt stood at around 64% of GDP in 2023, down from a peak of close to 90% in 2008.

Banks today have significant capacity to support businesses as they invest in productivity, innovation and expansion, while corporates have considerably more headroom to borrow, with stronger balance sheets and less existing debt.

Also, alongside traditional bank lending, private credit has become an increasingly important source of finance, giving businesses greater flexibility.

These dynamics point to a corporate sector better positioned to invest confidently in its future.

The UK has transitioned from a low deficit, low debt country to a medium deficit, higher debt economy. This is because of several external shocks, including the previously mentioned GFC and Covid pandemic, as well as the period of weak growth that followed.

However, it hasn’t dented investor confidence in the UK, which is important for future growth. According to the Investment Association, UK-based investment managers oversee around £10 trillion in total assets in 2024, on behalf of UK and overseas clients. That’s a record high.

Investors still see the UK as something of a solid choice, reinforced by its institutional credibility, legal certainty and globally trusted currency. But that’s not something we can necessarily take for granted, as shown by the 2022 mini-Budget which generated a big market reaction.

It’s also worth remembering that the UK is not alone. Many countries face high debt levels, and the UK actually has the second lowest share of government debt as a proportion of GDP within the G7.

With households and companies deleveraging, there are several developments that could potentially encourage them to resume borrowing and help accelerate growth.

For example, with interest rates now 1.5% below their most recent peak, appetite for borrowing should start to build in the household sector. Strong wage growth has improved the affordability of home ownership across much of the UK, although the top end of the market has added headwinds as it adjusts to the prospect of increased taxes.

Meanwhile, businesses across all sectors are grappling with how to accelerate the transitions they’re going through, whether for greater energy efficiency, digitisation, or implementing artificial intelligence. Those transitions have significant upfront costs, even if there are attractive payoffs in the long run, so we see potential for leverage to rise in the corporate sector too.

Taken together, the rotation of these debt dynamics could provide a very useful fillip to growth in 2026 and beyond, whilst remaining at a sustainable level.

As for Coutts’ investment approach, we are currently overweight sterling against the US dollar, and continue to hold UK equities in line with benchmark allocations across our multi-asset models. We are monitoring UK economic growth and note it could be supported by the private sector's capacity to take on more debt.

If stronger growth were to materialise, it could support our sterling overweight, but it would have a surprisingly limited impact on UK equities, given that around three quarters of revenue from companies in the UK FTSE 100 is generated from outside the UK.

The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. Past performance should not be taken as a guide to future performance. You should continue to hold cash for your short-term needs.