Economics Weekly - Can UK retail sales stay positive through the recession? Weekly economic data preview - Plethora of economic data and BoE quarterly Inflation Repor
Economics Weekly - 11 May 2009
Can UK retail sales stay
positive through the recession?
There appears to be a
growing view, most evident in equity markets, that the worst of the recession may be behind us. Behind this
perception has been a run of better than expected economic data, in the UK and elsewhere. Unfortunately,
the majority of the economic figures released are still consistent with
declining output, just at a decelerating pace. But there is one aspect of the UK recession that is
noticeable: the remarkable resilience so far of volume retail sales relative to
what has been happening to manufacturing output. In the year to February,
manufacturing output dropped to a level that was 13.8% below that in the same
period of 2008. By contrast, the volume of retail sales in the year to March
2009 was 1.5% higher than in the corresponding month of a year ago
Big contrast between
positive growth in UK retail sales and sharp
fall in manufacturing outputâ€¦
What are we to make of
the performance gap between the two series? One comment is that perhaps manufacturing
firms were carrying high stock levels ahead of the onset of recession and so
had to cut back on production whilst they cut inventories. In other words, they
overestimated consumer demand. Moreover, the 1.5% annual growth rate of retail
sales volume may be positive, but still represents a sharp fall from the 6% annual
increases seen a year earlier. So the fall in manufacturing output is sharper
lower due to weaker demand and because of the need to adjust stocks. In
addition, the crisis in global financial markets is hitting the financing of
international trade and it is that, combined with recession in the world
economy, which so far has impacted manufacturers more than it has consumers.
This is borne out by the fact that most forecasts now factor in a fall in the
volume of international trade in 2009, in annual terms at a post war record of between
10 to 14%.
These arguments may give
some rationale for why manufacturing output is falling faster than that of
retail sales volumes, but are no evidence that sales volumes will not respond
to the recession in due course. Looking at chart a, which compares the annual
growth rate of the volume of retail sales with that of manufacturing output, it
can be seen that in recession episodes manufacturing is much more volatile than
retail sales and leads. This is what we are seeing now and so the current
trends in the two series should not be a surprise. The chart illustrates that
during UK recessions, the trend of
retail sales tends to mimic the trend of manufacturing output, albeit to lesser
extremes. This suggests that unless manufacturing output turns positive very
quickly, which seems unlikely currently, the prospect is for there to be sharp
falls in the volume of annual retail sales growth quite soon, even though some
recent surveys of retail conditions are suggesting that sales are holding up
...but can it persist as
the household saving ratio rises and unemployment increases...
So why might retail sales
fall in the months ahead? To understand the factors at work more clearly it
might be useful to look at consumer spending in total - of which retail sales
is around 40%, and includes consumer durables, services and vehicles. Chart b
shows that actual consumer spending tracks overall economic growth very well.
Although we only have data for consumer spending up to Q4 2008, whereas we have
a provisional estimate for gdp up to Q1 of this year, the trend is clear: when
the detailed national account figures for Q1 are released they are likely to
show that consumer spending fell quite sharply. Why might this be and will the
fall persist? Chart c shows that in recessions the household saving ratio tends
to rise quite strongly. The higher the saving ratio, the lower consumer
spending growth. And the lower the saving ratio prior to a recession, the more aggressive
it rises during the recession. The peak saving ratio in recessions is usually
between 8% and 14% of personal disposable income. The average since 1970 to Q4
2008 is 7.8% but during recessions it is higher than this, at 10% of household
disposable income. In Q4 of last year, the UK household saving ratio went up to
4.8%, from 2.3% (Q2 2008) prior to the quarter that economic growth turned
negative (Q3 2008) and from -1.2% in Q1 2008.
...or will retail sales
and consumer spending soon fall back in line with the overall drop in economic output?
If the saving ratio went
up during this downturn to the average of the last 4 recessions that the UK has experienced, then it
could double from the 4.8% reached in Q4 of last year. If this were to happen,
then retail sales would likely fall quite sharply in the course of the year
ahead, but in line with the experience of past recessions in relation to
manufacturing output. One reason why this might happen is illustrated by the
relationship between unemployment and consumer spending during recessions, see
chart d. As the recession deepens, unemployment rises sharply and as it does so
consumer spending tends to decline equally sharply. Since the worst of the rise
in unemployment tends to occur with a lag to the economic cycle, so it is
likely that unemployment will rise considerably further before peaking. This
means that consumer spending has further to fall and the saving ratio further
The historical evidence
suggests consumer spending and retail sales may fall for some time
On one hand, retail sales
and consumer spending may not fall as sharply in this downturn as in previous recessions
because of the record low level of official short term interest rate, shown in
chart e. But, on the other hand, it is also true that as unemployment
increases, so average earning will fall, bearing down on consumer spending, see
chart f. More powerfully, chart g shows that in the last four recessions the
average duration of negative growth in consumer spending is around 10 quarters
or 2Â½ years. In this downturn, consumer spending has already fallen for two
quarters, so past recessions suggest that there is still 2 years to go before
it will begin a sustainable upturn. Worryingly, if this downturn is as long as
in the 1970s, perhaps due to the current high level of leverage in the
household sector, the fall in consumer spending could persist for another 2Â½
Plethora of economic
data and BoE quarterly Inflation Report
This weekâ€™s economic data
may provide a chill reminder that although there are tentative signs that the
pace of output contraction is slowing, the major economies are still in deep
recession. EU-16 GDP is likely to have fallen at a faster pace in Q1 than in Q4
2008, while in the UK, the unemployment rate could rise to 7% of the workforce,
the highest figure in almost twelve years, see charts below. However, it is
possible that we may see in the monthly incoming data more evidence that
economies are stabilising, albeit at low levels. This would underpin the more
upbeat trend expressed in recent business surveys. Nonetheless, pressure is on
central banks to keep monetary policy loose, as availability and demand for
credit remain inhibiting to recovery. In the UK, the BoE May quarterly
Inflation Report may show the margin of spare capacity to be greater than
expected in February, representing an increased risk of price deflation and
providing justification for the BoEâ€™s decision last week to increase the size
of the asset purchase programme from Â£75bn to Â£125bn. Economic data may
continue to indicate that the US will lead recovery ahead of Europe, backing the
Fedâ€™s recent less pessimistic economic outlook.
ô€‚„ Business surveys have shown an increase in confidence and this may
be reflected in industrial production figures for March - output may have
fallen by 0.8%, compared with 1% in February and considerably less than the
record 2.7% fall in January. However, on an annual basis, the March figure
still represents a very steep decline of around 13%. Within the detail of the
data, manufacturing output may have dropped 0.9% on the month, 14% annually -
the collapse in global trade appears to be a major contributing factor. Also,
the BRC retail sales monitor and the RICS and official DCLG house price indices
will provide useful clues about conditions in the high street and the pace of decline
in house prices. Moreover, the NIESR 3-month rolling GDP estimate for April is
likely to provide more evidence that the recession is easing; we will be
looking for a smaller contraction than the -1.5% reported in March. On a more
negative note, the UK official labour
market report is likely
to show the unemployment rate rising to about 7% of the workforce in March from
6.7% in February and average earnings may have contracted on a 3-month rolling
annual average basis for the first time since records began in 1964, both
discouraging recovery in consumer spending. Manufacturing unit wage costs may
continue to rise close to 10%, leading to reduced profit margins.
ô€‚„ The US also has a heavy economic release calendar - external trade
data, industrial output, retail sales and consumer prices. If recent economic
surveys are to be relied upon, we may see just a small contraction in retail
sales and a 0.5% drop in industrial production in April compared with a larger
1.5% fall in March. However, firms are likely to be operating with considerable
excess capacity - capacity usage may have dropped from 69.3% in March to 65% in
April - keeping up pressure on firms to slash jobs. We are looking for an
external trade deficit of $29bn in March, slightly worse that the record low of
$26bn in February, but a huge improvement since the start of the recession. In addition,
consumer price deflation may have accelerated to 0.6% on an annual basis in
April, compared with 0.4% in March, suggesting that the Fed will need to keep
up the pace of monetary easing.
ô€‚„ The most important EU-16 release is Q1 GDP - it will confirm
expectations that the eurozone economy contracted by around 2%, compared with
1.6% in Q4 2008. Germany will lead the decline,
with a contraction of 2.6% compared with a 2.1% decline in the previous
quarter, as industrial output and exports have been severely affected by global
recession. The negative drag of the German economy on the rest of the region
may provide justification for the ECBâ€™s plans to purchase covered bonds, which
are widely used in German capital markets. As with other major economies, the
rise in spare capacity in the eurozone means that it will take longer for
inflation to return back to the 2% target once economic recovery begins;
President Trichet confirmed last week that CPI inflation will remain below
target until 2011. This view underpinned the ECB governing councilâ€™s comments
that 1% official rates are not necessarily the floor, although it seems
unlikely that economic conditions will warrant a further rate cut as surveys
suggest that business confidence is improving.
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