23 Mar 2017

UK retail sales – upside surprise in February, wider picture unchanged

Philip Shaw

Chief Economist

Figures on UK high street activity were significantly stronger than expected in February. Retail sales volumes jumped by 1.4% on the month (consensus and Investec +0.4%), following three consecutive monthly declines. Sales in non-food outlets rose by 1.8%, while food store sales gained by just 0.1%.

Our view has been that the rise in prices on the back of the weakness of sterling has begun to impact on the volume of sales and will act as a brake the economy over the next few months. Despite today’s relatively firm data, this judgement remains intact. Indeed taking the three months to February, sales volumes declined by 1.4% on the previous three months. This may well exaggerate the underlying slowdown – we are not convinced that sales are actually falling. But the main point is that the gain of close to 5% recorded in 2016 is not going to be repeated in 2017.

The figures also reminded us that prices are rising. The annual change in the retail sales deflator stood in negative territory as recently as October last year – last month it had climbed to +2.8%. In fact high street prices (seasonally adjusted) have risen by 1.4% over the past three months alone. The most recent data on pay show that earnings in January rose by 2.2% on the year, which gives some indications of the squeeze on household spending power. Tax breaks and rising employment should provide some offsetting factors on household incomes in aggregate. But the wider picture seems clear. Consumer spending growth is about to enter a weaker phase and GDP is set to slow.

Earlier in the morning BoE Deputy Governor Ben Broadbent spoke about ‘Brexit and the pound’. An interesting observation was that, in contrast with textbook orthodoxy on a weaker currency, the drag on spending though rising inflation may outweigh the positive effect from improved external competitiveness, partly due to a relative shortage of spare capacity in UK industry to meet higher demand. In terms of our own forecasts, we have been musing whether the performance in the British ‘tradables’ sector would outweigh the negative impact from consumption. It is interesting that these questions are also being discussed at the BoE.

Sterling rose above the $1.25 level following the data. However today’s figures do not change our assessment of the shape of the outlook for the economy and we maintain that a slower pace of economic growth will undermine the case for higher interest rates this year.