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Economics Weekly: Can UK consumer spending growth recover this year?

Economics Weekly: Can UK consumer spending growth recover this year?

Weak retail sales threaten economic recovery
Last year saw UK consumer spending grow slower than overall gdp for the first time since 1995. Although the difference was small, consumer spending rose 1.7% in 2005, while gdp rose by 1.8%, the significance is that with consumer spending still under downward pressure, there are doubts about whether economic growth this year can be any faster than in 2005. We look at the likely outcome in this week’s economic briefing, concluding that UK economic growth is likely to accelerate despite current weakness in retail sales.

Legitimate reason for concerns about the sustainability of consumer spending exist…
Worries about weak retail sales and the impact that this could have on gdp are relevant and valid. Retail sales account for some 35% of consumer spending, which in turn accounts for 70% of the expenditure measure of UK economic output. If retail sales growth does not recover and consumer spending stays weak, then the economy is unlikely to grow faster than last year’s 1.8% pace, which was the weakest since 1992. Charts a and b highlight two of the major worries about retail sales. In chart a, it can be seen that retailers are continuing to struggle, and firms expect their sales to stay weak. Whilst this is not as weak as the low point reached last year, it is still weaker than at any time in the preceding four years. Worry about the ability of UK consumers to increase spending is also based on the rise in their debt. Chart b shows that UK households have outstanding borrowing of around £1.2trillion, mostly through mortgages. The legitimate fear is that this will constrain consumer spending and prevent economic recovery from taking place this year, at least without further cuts in interest rates. This is especially the case, the argument goes, as unemployment is rising and consumer confidence is falling. Add in the hits to income from higher petrol prices, increased gas, electricity and council tax charges and consumer spending is as likely to fall as to rise.

…but we still expect a recovery…
But we think that consumer spending can still recover for a number of reasons. Whilst it is true that indebtedness is high, so are assets. Household net worth at the end of last year was some £6 trillion. Net of mortgage debt, UK households are sitting on some £2.4trn of wealth locked in their property. The strong rise in equity prices this year and recovery in house prices have boosted household wealth, see chart c. In the three months to March, house prices rose by 2.2%. All of the surveys that monitor house prices are up – ODPM, RICS, Home track, Rightmove etc. This may entail a continued low saving rate, because as housing wealth rises, people tend to borrow more, save less and spend more. Our analysis of the link between mortgage approvals data and house prices indicates that house price inflation will hit 10% this year, more than sufficient to support increased spending. Supporting this view, chart d shows that consumer spending growth tracks mortgage approvals. Since the latter is trending higher - despite a fall in February to 115,000 from 121,000 in December and January, the level in the latest three months is 44% higher than a year earlier- there is underlying support for a rise in consumer spending.

But there are also other reasons for expecting consumer spending to recover as the year progresses. Unemployment has risen but is still at a 30 year low and employment is at its highest on record, and still rising in year and year terms despite the rise in unemployment. Wage inflation has slowed but is still rising at about 4% a year, twice as fast as price inflation, so that real wage increases are in line with the long run average. Money supply growth is very high, and is being followed by retail sales and house prices, see chart e. Consumer confidence has fallen, but as chart f shows its level is still consistent with an acceleration in retail sales volumes. The chart also indicates that retail spending growth is in fact recovering from the low point reached in Q1 2005.

…and for economic growth to be just above the long run average in 2006
This expected recovery does not mean a boom in consumer spending is in the offing, we are looking for a rise of around 2.5% in 2006 on average but this will be up by nearly 1% from a year earlier though well below the 3% plus average of the previous 5 years. That will be enough in our view to result in growth of 2.5% in the overall economy in 2006, up from 1.8% in 2005.

Trevor Williams, Chief Economist
trevor.williams@lloydstsb.co.uk
www.lloydstsbfinancialmarkets.com
Lloyds TSB Bank,
Financial Markets
Division,
Faryners House,
25 Monument,
London EC3R 8BQ
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