British retail sales dropped more than expected in September, coinciding with the sharpest drop in consumer confidence in more than three years, snapping signs of a recovery in August. The retail sector faces persistent challenges, including declining real wages, the enduring cost of living crisis, historical inflationary pressures, and the delayed impacts of increased borrowing costs, pushing up mortgage costs, as well as rising petrol prices. These headwinds will continue to test consumer resilience as the retail sector braces for the pivotal Christmas season.
In September, retail sales volumes registered a 0.9% m/m drop, well below the -0.2% m/m consensus forecast, according to Office for National Statistics (ONS) data. It marks the lowest retail sales volumes since December 2022. Quarterly retail sales also down fell by 0.8% in the three months to September, compared with the previous three months. The GfK consumer confidence index – which tracks personal finance sentiment and broader economic prospects – fell nine points from minus 21 to minus 30 in October. September’s retail sales and October’s consumer confidence both reversed sharply on a respite in August. The weakness ahead of the crucial festive season will alarm retailers. GfK said the sharp sentiment fall demonstrates that “the cost-of-living crisis, and simply not having enough money to make-ends-meet, are still exerting acute pressure for many consumers”. Heightened geopolitical risks likely added to a growing unease, along with accelerating energy and petrol costs, surging mortgage and rental rates.
During the three months to July, nominal wage growth also surged at a rate of 7.8% (excluding bonuses), the fastest pace since records began in 2001, according to ONS data. Notably, real wages continue to decline. In the near term, the rise in average nominal wages surpassing consumer price increases is enabling retailers to pass on their reduced input costs to customers. Fashion retailer Next reported better than expected sales and lower costs, with CEO Simon Wolfson acknowledging the support provided by nominal wage increases and the robust UK job market. The strength of the employment market remains pivotal to sustaining consumer demand, seemingly defying the cost-of-living pressures. This can be partly attributed to the drawdown of household savings. However, tight labour markets have also empowered workers to negotiate higher wages and work longer hours, boosting their earnings. The eventual softening of the labour market represents a mixed blessing for retailers, as it may alleviate wage inflation pressures, but could also weaken consumer demand growth, which has buoyed retailers throughout 2023.
Higher for longer narrative and hidden lagged effects
The downside surprise to annual headline inflation of 6.7%, according to the ONS, was enough to convince the data-dependent Monetary Policy Committee (MPC) to pause rate hikes for the first time in almost two years. Policymakers voted on September 21 to keep the Base Rate unchanged at 5.25%, the highest level in 15 years. Revised ONS data shows GDP grew by 0.2% in the second quarter, while Q1 growth was revised upwards to 0.3%. The UK economy was 1.8% larger than its pre-pandemic level, contrasting with earlier estimates of a 0.2% contraction. Economists anticipate that the robust economic momentum in the first half of the year has started to fade, with Capital Economics forecasting a mild recession causing a 0.5% GDP contraction in the coming quarters.
Retailers’ macro respite may prove short-lived
While rising nominal wages, moderating inflation, and signs of a loosening labour market offer some support to retailers, these factors remain historically high. Retailers and households have yet to fully absorb the impact of higher borrowing costs. By the time these delayed effects are realised, there is a risk that the economy’s momentum has waned and retailers will be caught between falling revenues and higher debt repayments, ultimately squeezing margins. Headline inflation remains significantly elevated, which is a concern for Bank of England policymakers, and the potential persistence of high oil prices into winter could exacerbate this situation.
High borrowing costs are expected to persist uncomfortably for retailers into the next year. Earlier this summer, discount homeware and hardware chain Wilko called in the administrators after the retailer was unable to secure emergency funding to save the 400-strong UK stores. Wilko’s performance faltered under the weight of rocketing interest rates, high levels of inflation, and tightening household incomes. Under these trading conditions, Wilko struggled to pay suppliers. Many retailers may similarly struggle under these conditions, potentially leading to further restructurings and insolvencies in the months ahead.
At the same time, MPC policymakers are mindful of the embedded inflation risks in the UK economy, stemming from continued demands for higher wages in a tight labour market, potentially triggering a wage-price spiral. Given that the retail sector is labour-intensive, operates on thin margins, and is highly competitive, it is particularly sensitive to this scenario. Additionally, retailers are bracing for an increase in business rates of more than £400m per year, determined by September’s CPI, as highlighted by the British Retail Consortium.
While UK retailers have been supported by nominal wage growth and cooling inflation, the delayed impact of higher borrowing costs poses a significant challenge for the retail sector in the coming quarters. Capital Economics’ analysis reveals there has been a 2% erosion in real disposable incomes since Q3 2021, driven by surging inflation. This will be exacerbated by households refinancing maturing short-term fixed-rate mortgages in the months ahead, curbing discretionary spending. As a result, economists forecast that real consumer spending will decline by 0.5% from its peak over the coming quarters. The retail sector must remain vigilant in the broader economic environment and needs to prepare to offset these incoming headwinds to ensure they survive.
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