March 7, 2022

The unfolding situation in Ukraine is of course fundamentally a crisis that will be remembered in terms of the needless loss of lives. The economic sanctions put in place against Russia will cripple that economy and deepen and extend the cost-of-living crisis in Western economies.

In the UK, inflation is set to peak above 8% as petrol prices reflect the spike in the cost of crude oil. And unless wholesale gas prices ease, another big rise in energy bills is on the cards in October. The inflation rate is likely to still be above 6% at the end of the year.

Given this, household real income could fall around 3% in 2022, an unprecedented contraction in modern times. The last big squeeze was in 2011 when real income fell 1.8%, another period of high inflation.

How will this affect credit risk? It is hard to model the impact of an unprecedented event. Ideally banks will have an assessment of customer affordability which gives an estimate of the buffer borrowers have in this situation. Elsewhere models that use nominal income can be used to try to calibrate Post Model Adjustments.

Many households built up savings during the pandemic. That might insulate some. But the big concern is centred on households at the bottom of the income scale. They spend more of their income on energy and could see a drop in real income of around 6%. The number of people registering for “breathing space” from creditors rose sharply in January. And the huge rise in energy bills in April will only bring more stress to these households.

Do you have any questions? Please contact info@4-most.co.uk