The investment to GDP ratio will fall from its nearly 30% level of 2008, to 26% in 2010, both figures in prices of 2003. Private consumption has been the component of domestic demand least affected by the crisis, and is expected to close 2009 with a slight increase driven by non-durable consumption. Consumer expectations have turned optimistic in the latest data, after two and a half years in the pessimistic zone. The not so restrictive financial conditions have also helped consumption and, most specially, its prospects. The Banking Credit Survey of the third quarter showed that more banks have eased their lending conditions, while at the same time demand for banking credit has increased from the previous quarter. The increase of household debt recovered slightly, particularly for consumer borrowing. The ratio between total household debt and disposable income fell in the last two quarters, as did the ratio between the financial burden (principal and interests) and disposable income. This latter decline obeys to both a fall in borrowed amounts and lower interest rates (figure 10). As underscored in our Financial Stability Report, these BIS Review 9/2010  3  adjustments are welcome from a financial stability perspective, because of the higher risk of redundancy faced by households this year. Given the lags between the recovery of output and employment, both households and lenders must continue to be cautious for some time. The performance of the labor market also supports the prospects for consumption. Latest data show that the decline has stopped.

7  All speeches are available online at www.bankofengland.co.uk/news/speeches  7  For example, micro data studies from the UK, US, Denmark and Norway have all found statistically significant correlations between higher levels of household debt and the size of consumption cuts in a shock.13 And macro studies have also found correlation between rapid credit growth and the severity of downturns.14  But new studies have also sought to deepen the knowledge base. In particular, they have looked at why more highly indebted households cut consumption in response to shocks – the channels through which the observed association is working. For example, there could be debt financed ‘over-consumption’ prior to a downturn that is then cut back when expectations adjust to reality or credit becomes unavailable. This channel might work directly through unsecured consumer borrowing or through mortgage financed borrowing to consume. Alternatively, there are channels through which higher levels of debt constrain household budgets without appealing to ‘over-consumption’: some indebted households may be unable to consume as much as they would like in a downturn because they do not have a sufficient buffer of liquid savings and find themselves unable to access additional credit when they need it the most. This situation is more likely when falls in house prices reduce the value of the borrower’s collateral. The situation is also likely to be exacerbated if the downturn is accompanied by rising uncertainty. The combination of rising uncertainty and credit constraints would tend to lead to further reductions in spending as households build precautionary buffers.