European savings buffers may temper economic fallout from oil shock

If a hit to household finances is what dictates the economic impact of this oil shock, then European households have more savings insulation than their US counterparts, tempering a narrative that Europe stands to suffer far more.

The Iran conflict may well be winding down. But eight weeks ​of sky-high oil and gas prices, and a likely slow return to normal over many weeks and months, mean trepidation about the economic fallout persists.

The oil shock undermines the economy ‌in a variety of ways – soaring input costs for companies, squeezed transport costs and airfares, government tax breaks and subsidies to soften some of the blow and a surge in headline inflation rates for everyone that could well bring higher borrowing costs to boot.

But the direct drain on household wallets is perhaps the most immediate as higher fuel costs eat into disposable incomes and curb spending.

Economists talk of businesses and workers “seeing through” a temporary shock. But how far households can do that depends, at least partly, ​on what they have saved up in advance.

On that score, the US savings picture just before the war’s outbreak looks a touch worrying, sitting far below historic norms.

At just 4 per cent in February, ​the personal savings rate – or savings as a share of after-tax income – was close to its lowest in more than three years and had tumbled from a ⁠26-year average of 5.5 per cent, as recently as last April.

The annual growth in disposable income fell over the same period to 3.9 per cent from 5.1 per cent and real, inflation-adjusted annual growth in this measure was running at just 1.3 per cent ​at the end of last year – its slowest in three years.

US inflation, which was already picking up a gear this year, has been boosted sharply by fuel costs since the Iran war. Taken together, that picture of US personal finances ​suggests little room for manoeuvre in a prolonged energy bind.

The pre-war picture partly reflects the sort of resilient consumption that kept broader economic growth brisk over a turbulent 12 months. But it also suggests another price hit could now eat into spending, or push poorer households deeper into debt.

BIGGER SAVINGS POOLS

By contrast, the personal savings picture in Europe is much more robust. That robustness is a problem in its own right, reflecting more sluggish aggregate consumption ​and a glimpse of the so-called “paradox of thrift.”

A euro zone savings rate of 14.4 per cent at the end of last year was far higher than for American households and also about a point higher than the average ​of the 26 years of the euro.

At close to 10 per cent, Britain’s household savings rate is more than a point above the average of the century so far.

On the face of it, the higher European savings rates give the region’s ‌workers more of ⁠a buffer to weather at least a temporary energy hit without incurring additional debt.

Better-performing US asset wealth may have encouraged American households to spend more of their incomes over time, though that does not fully explain the past 12 months, when European markets largely outperformed.

There are multiple caveats, however.

ING economist James Smith outlines several reasons to be careful in interpreting the contrasting transatlantic picture.

For a start, he doubts European workers will spend more of their savings as uncertainty rises and may even do the opposite. Structurally higher European interest rates than in the pre-pandemic decade may do much to hold them there – and argue against further rises too.

Official savings rates are also constructed by splicing together separate income and ​spending data series to impute overall savings behaviour. In truth, ​they miss many important complexities and are subject ⁠to huge revisions.

Smith argues central bank data on money in bank accounts is a more concrete measure of savings. He notes that European deposits as a share of household disposable income are actually below pre-pandemic levels.

But perhaps the biggest problem with the numbers is that most savings are generated by the wealthiest households – least affected by the energy shock. And aggregating ​the overall picture misses that point somewhat.

Smith pointed to Fed data showing the top 20 per cent of US earners hold 70 per cent of savings and ING surveys ​show almost a quarter of ⁠European households have no savings at all.

That distributional skew is one reason this oil shock may ultimately pack more of a political punch than a macroeconomic one.

How long the squeeze lasts remains to be seen, but it’s always worth treating both the dominant narratives and the datasets behind them with some care.