Hamish McRae: We're the champions of borrowing, but this rate rise must work in reining us back

I learnt a new fact last week. It is that the household debt of Britons - our mortgages, credit cards and so on - is greater than the entire national debt of Africa and Latin America combined. This will now sit alongside my other fact - that Britons owe more on their credit cards than the whole of the rest of Europe put together. We are champions at borrowing.

How bright is this? Interest rates are going to go up next week, bankruptcies are soaring, the banks are facing huge default rates on personal loans. So it is just the moment for Abbey to offer people a mortgage equivalent to five times their income. Those Spaniards (for Abbey is now owned by Banco Santander) must know something we don't.

That might seem a cheap shot. After all, loans like these are only for high-earners who presumably know what they are doing. They will be scrutinised and are secured against an asset. Still, the Spanish property market must have coloured group perceptions, for last year the country started building 900,000 housing units, which on my quick calculation is almost as much as the rest of Europe put together. That boom is already showing signs of strain, whereas in Britain, which builds only 150,000 a year, the market is underpinned by lack of supply. So it is safer to lend on houses here than in Spain.

The fundamental point, however, is that the UK economy, for a variety of reasons, requires higher interest rates to restrain it than do most other developed countries. The Bank of England will push rates up to 5 per cent next week (it would be a huge surprise if it did not), and there is a debate as to whether there will be a further rise in the spring. My own view, outlined here a couple of weeks ago, is that a peak of 6 per cent this cycle is conceivable.

One reason is the soaring money supply, the broad measure of which is rising at 14 per cent a year - double the rate between 2001 and 2004. To worry about money supply might seem a rather 1980s concern, for inflation targeting is now the Bank's main discipline. But if there is a lot more money being created, there has to be a reason and it has to go somewhere. It is hard to believe that the rapid rise is not in some way associated with the rise in asset prices, particularly property.

But if we are prepared to borrow more to buy homes, and mortgage lenders are prepared to lend us the money, we are not so keen about borrowing to buy consumer items, and the lenders are equally cautious. Net consumer lending is still rising but at a much slower rate than a year ago. You can see why when you consider the bad-debt crisis, further details of which were published on Friday by the Government's Insolvency Service.

The job of the service is to choreograph the whole bank- ruptcy and insolvency process, from administering the affairs of bankrupts to regulating the professionals who deal with this. Its figures showed that bankruptcies have risen by 26 per cent on last year, while the new, or newish, individual voluntary arrangements are up 118 per cent. IVAs are a sort of halfway house, where people agree to pay back part of their debts and avoid being declared bankrupt.

In addition, banks and other mortgage lenders are taking out more proceedings against debtors. Actual repossessions are still very low but the number of such orders is the highest since 1993. Lenders will have to make sharply higher provisions for bad debts in the coming months.

One reason for the surge in bad debts is the change in legislation, with reduced penalties for declaring bankruptcy and the growing use of IVAs. In the "can't pay/won't pay" mixture of cases, there is probably a greater element of the "won't pay" than used to be the case. Many companies now specialise in advising people, for a fee of course, in how to negotiate an IVA with their lender. So people walk away from their credit-card debt but keep up the payments on their mortgage, which I suppose is the sensible course of action, though in the medium term it will increase the cost of all unsecured credit. Banks may have behaved stupidly, scattering credit cards across the land to people who were unlikely to use them responsibly, but they will learn from their mistakes. Non-creditworthy people will not get credit, as well as credit-worthy ones paying more for it.

If the country marches on up towards 6 per cent rates, then the pressure on both secured and unsecured borrowers will really climb. The left-hand graph above shows how the bounce-back of mortgage lending has revived the housing market. If that relationship, charted by GFC Economics, holds, the annual rise in prices might reach 20 per cent or more - a level at which the Bank would surely become seriously alarmed. It will be a bit of a test case whether the 5 per cent rate slows the housing market at all. If not, expect the upward march to continue and bad debts to rise correspondingly.

For the moment, though, people are not that concerned about their overall financial position. The right-hand graph, from Barclays Capital, shows how the balance of those expecting their financial position to improve has remained positive. Indeed it carries on, as it has since the late 1990s, at very high levels and is in sharp contrast to the gloom of the 1970s and of 1990 and 1995. The interesting thing here is that the slight deterioration in people's concerns about unemploy- ment is not reflected in any deterioration in their assessment of their financial position. It is a "I suppose I might lose my job but I should still be OK" attitude.

That's good and probably realistic, at least for now. After all, the economy is still creating jobs, even if unemployment is rising thanks to the increase in the size of the workforce. What is more disturbing, though, is the rise in the number of people who find themselves in financial difficulty at a time of decent growth and record employment. Clearly a lot of people are running close to the limit, betting that interest rates will not rise much further and solid economic growth will continue. There is no cushion against not just bad times, but not-quite-as-good times.

It would be silly to get worked up about the quarter percentage point on rates next week. But unless that is successful in curbing our borrowing habits, there will be another quarter per cent, and maybe yet more, to come.

Germany's revival will give us all a boost

Good news from Germany: unemployment has fallen below 10 per cent on the country's usual measure for the first time for four years. OK, you may think, but not quite worth opening a bottle to celebrate.

But I think it is, for the fall in unemployment has been accompanied by rising productivity, rising tax revenues and better-than-expected growth. Germany seems to be perking up. And since it is also making modest reforms to its welfare system and job market, helping to drive growth, Chancellor Angela Merkel should take a bow.

I was in Frankfurt a couple of weeks ago talking with bankers and fund managers, and found myself trying to cheer them up. Oh, they were saying, we are still only inching forward - the public sector is so huge and so many people have a vested interest in maintaining the status quo. If only we could have your flexible labour markets... and so on.

That is all true, but given the still-tight constraints in which German companies operate, they are being very successful. The general point is that Germany has become super-competitive at the present euro rate, having held down its costs for the best part of a decade. The economic team at UBS points to wider European productivity improvement, which is helping to push the eurozone into a virtuous circle. More efficiency leads to higher exports and employment, which in turn leads to higher consumption - and so on.

This is all helped in Germany by improved public finances, themselves largely due to higher tax receipts from profitable companies. The largest part of the windfall will go in reducing the deficit, but the grand coalition looks to be cutting social-security contributions, too. That will put more money into people's pockets and purses, which will in turn increase consumption, which will in turn increase VAT tax revenues.

True, the recovery is still fragile; true, the European Central Bank is on course to push up interest rates, though it is hard to judge how far. And remember that Germany is set to increase VAT next year - an invitation to people to buy big-ticket items now rather than in January. But I do think the idea, always a bit silly, of Germany as the sick man of Europe will fade in the months ahead. And of course, progress in Europe's largest economy is good news for Europe's second-largest one: our own.

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