In the wake of the COVID-19 pandemic, European consumers have been on a savings spree, hoarding cash like never before. While this has provided a much-needed buffer during times of economic uncertainty, it has also left a significant dent in their spending power. The issue is that despite a slight uptick in household spending in recent quarters, Europeans continue to save a much larger share of their income than before the pandemic, limiting an important driver of economic growth. This is particularly concerning when compared to the United States, where the gross savings ratio has come down from pre-Covid levels, and household consumption continues to provide strong support to the economy. The effect is a lack of household spending, which is weighing on growth, both relative to historical levels and even more so relative to the US. For years, a gradual normalization of the savings ratio towards pre-Covid levels was seen as a potential source of support for European growth, but so far, there has been little meaningful progress. The surprising driver of this change is older households fearing the erosion of their wealth. Recent research by the Bank of England suggests that reduced inflation uncertainty, which is strongly correlated with lower expected inflation, leads to higher planned spending and lower monthly saving. However, in Europe, the real value of household wealth fell sharply between 2021 and 2023 as inflation peaked, making older households more exposed to the erosion of purchasing power. At the same time, older people tend to have significantly higher inflation expectations than younger people, which may lead them to postpone consumption and rebuild financial buffers. The opposing forces are younger generations saving intentions peaking. Since the outbreak of the war in Iran, inflation expectations have risen across all age groups, but older age groups seem slightly less inclined to save than before, while younger households are stepping up precautionary saving. The data suggest that the slight first-quarter dip in the savings ratio reflects two opposing forces: older households drawing down part of their reserves and younger households building up cash reserves for precautionary reasons. Looking ahead, the savings ratio is likely to slip further in the second quarter as households tap their financial buffers to offset the surge in fuel costs, but precautionary saving is likely to re-emerge as the dominant force in the coming quarters. Mortgage dynamics will reinforce this shift, with demand for new mortgages cooling and repayments picking up. In the third quarter, any lift from easing inflation is likely to be muted once again by a rising savings ratio. What's new is that fewer deposits and more investments are being made. Following the Covid pandemic, eurozone households initially channelled large amounts into bank deposits and debt securities, but since 2024, financial transaction data shows an increasing share is going into investment funds, insurance, pensions, and standardized guarantees. The longer-term implication is positive for growth, as household balance sheets show that as more savings have shifted into investment funds, pensions, and other market-linked products, the share of liquid financial investments in total wealth has increased. If Europeans continue to allocate more of their savings to investment products, the need for precautionary buffers could gradually fade, and domestic demand could get a lasting boost.
