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Tuesday May 30, 2006 - 11:17:38 GMT
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Economics Weekly: UK retail sales growth to accelerate in Q2, boosting economic growth

Economics Weekly: UK retail sales growth to accelerate in Q2, boosting economic growth

Retail sales were a drag on growth in Q1
Figures for UK economic growth in Q1 showed that real consumer spending only grew by 0.2%, well down from 0.7% in the final quarter of 2005, while retail sales fell by 0.6%. With overall economic growth of 0.6% in Q1, the same as in the previous quarter, this means that consumer spending grew at its slowest pace since Q1 last year. With the world cup for football starting in June, one question is whether stocking up on drinks etc ahead of the event will boost retail sales activity in the second quarter. We think that this is not the key to a sustainable recovery, however, and so almost irrelevant; more likely is that a recovery in consumer confidence and continued falls in the retail sales deflator will be instrumental in driving forward retail sales volumes in the quarter ahead.

Retail sales growth stalls in Q1…
As chart a shows, retail sales and consumer spending are linked but are not one and the same. Retail sales account for about 40% or so of consumer spending, with the rest taken up by household spending on durable goods and on services. What is interesting from the chart is that retail sales activity has been faster than that of consumer spending between 2003 and the middle of 2004. Its recent recovery should therefore not be seen as a surprise. However, both currently lag overall growth in the rest of the economy. In Q1, the ONS said that retail sales fell by 0.6% and this is undoubtedly a concern for those predicting that UK economic growth will accelerate this year.

...but recovery is already underway
However, latest indications from the monthly retail sales data suggest that a recovery is already well underway, shown by the three month moving average in chart a. Retail sales volumes rose by 0.6% in April, increasing for a third consecutive month. The March rise was also revised up, to 0.9% from 0.7% previously. This helped lift the annual rate to 3% compared with April last year, from just 1% on a comparable basis in January 2006. The real question should be how much retail sales add to economic growth in Q2, not whether it adds anything at all. Charts b and c show the detail of the latest monthly retail sales release. Sales by food and Internet mail order retailers fell in April but non-food store sales rose by a robust 1.4% in the month. Within the detail of this category, strong increases in textiles, clothing and footwear, which rose by 0.8%, were a major feature. But there were also increased sales from house- hold goods, which leapt by 3.3% in April. A strong housing market may finally be boosting the latter sector, while falling prices in clothing and footwear goods are boosting sales in that category. In April, the retail sales deflator fell by 1.2% though it was up slightly on the year before, see chart d. Increasingly, it will become difficult for retail sales goods prices to remain negative year-on-year but intense global competition will likely keep down the price of imported textile goods (though less so for others) for some more years yet.

...and retail sales growth is set to rebound strongly in Q2
Our calculations show that even if sales volume remained unchanged in May and June (with a flat profile most unlikely that month), it will rise by around 1.4% in Q2, adding 0.3% or so to economic growth in that quarter on its own. Our take on volume retail sales is that, despite worry that it is the ‘soft underbelly’ of economic recovery, it will be supporting expectations of higher interest rates in coming months. Chart e shows that consumer confidence is recovering and its close association with retail sales see chart , points to acceleration in retail activity. Consumer confidence is in turn linked to employment and unemployment trends. On the surface these would seem to be a negative, given recent evidence of weakness, but job growth is still positive, outweighing the negative of rising unemployment. Rising unemployment is down to more people joining the labour force than can immediately be found work rather than to a lack of demand for labour. Moreover, monthly growth in M0 is now running at 7.5% year-on-year, as growth in broad money supply accelerated to 13.1% in April. These figures are compatible with above trend growth in gdp, and, incidentally, therefore incompatible with 4.5% base rates. But with inflation on the MPC target of 2%, and the recent volatility in equity markets, any interest rate rise in 2006 is more likely to be later in the year than sooner.

Trevor Williams, Chief Economist
[email protected]
Lloyds TSB Bank,
Financial Markets
Faryners House,
25 Monument,
London EC3R 8BQ
0207 283 - 1000

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