Britain finally faces up to financial reality and reins in on spending

Alliance Trust Research Centre's Financial Reality Index highlights the worsening financial reality facing households and points to household spending growth cooling over the year ahead.

For the past two years consumer spending diverged from the underlying financial reality as consumers continued to spend despite a worsening financial situation. However the results show that, in the current credit squeeze, consumer spending has finally begun to cool. Britain's net wealth has started to feel the chill, because for the second successive quarter the decrease in the value of equities and the cooling of house price growth, occurred simultaneously and thus forced a decline.

The Financial Reality Index is a bespoke gauge of consumers' real financial well-being. It collates and analyses findings across a range of economic variables, from wage inflation and employment statistics to mortgage repayments and council tax. This quarter the index fell to its lowest point since the study began over 10 years ago.

In the first quarter of 2008, with the credit crunch in full swing, household budgets remained under considerable strain. This was caused by low real disposable income growth, high council taxes and rising mortgage payments, and was further compounded by the increase in everyday living costs. For example, the latest statistics show that food prices have risen 6% over the last year and fuel prices have surged by more than 20%.

Head of Alliance Trust Research Centre Shona Dobbie said, "Our latest report highlights that consumers are starting to feel the pinch of financial reality, and are showing signs of reining in spending. Our measure of consumer wellbeing shows households are facing increased headwinds in terms of their finances, as food and energy prices move higher, house price growth slows and equity markets decline. These combined factors give us a bleak view of consumer spending and confidence for the next 12 months. To add further pressure on household budgets there are millions of homeowners who are coming to the end of cheap fixed-rate mortgage deals, who will now face higher repayments. This will have a huge impact on people's finances so we expect to see a further decline in household expenditure closely aligned with financial reality over the next year.

"Given the continued strain on household budgets, we expect consumer spending to slow even further in the next 12 months. Over the last two years debt levels have increased as household spending rose, despite a worsening financial reality, however this trend is coming to an end. If the equity markets and property prices continue to fall, we could see net wealth drop further, dragging the Financial Reality Index to an even lower level."