Getting real...?

Despite continuing problems in the financial sector, UK consumers are defying the odds and doing what they know best - shopping.

Latest news from the high street shows that spending in February rose by 1% in February. Analysts had expected a fall of 0.2%.

The article from the BBC concludes:

“February’s surprising sharp jump in retail sales, if taken at face value, suggests that a consumer slowdown hasn’t even begun yet,” said Vicky Redwood, an economist at Capital Economics.

“It’s hard to see what is keeping consumers spending. Yet these figures suggest that they certainly are, boosting the chances that the Bank of England’s Monetary Policy Committee will hold on to May before cutting interest rates again.”

But surely the tightening of credit in the financial sector must have some impact on the real economy? Here are my three reasons to be gloomy....

Both existing and new borrowers now face tighter criteria when they apply for remortgages or new loans. With the days of the ‘six times joint income’ multipliers over for most, this must have a dowward effect on the prices buyers are able to pay for housing.

Rising house prices have fuelled a ‘wealth effect’ boom in recent years but as banks tighten lending and struggle to find the credit to provide loans, without this positive impact on spending it is inevitable that consumption will have to move closer in line with incomes in the coming months.

Another dampening impact on spending must arise from the slump in share prices. Households typically hold wealth in housing and shares (including stock options and pension funds) and both these sectors are suffering at the moment.

Now for the good news.... we have already seen that retail sales are showing little sign of decline, but unemployment is falling too. Latest data shows that both measures of unemployment showed a fall in February and average earnings rose at an annual rate of 3.7%. This helps, perhaps, to explain the 2.5% inflation rate in the UK at present.

However, inflation can be both a sign of strong growth and confidence or a cause for concern in itself. Recent inflationary trends are linked to higher energy, fuel and food prices. This means that (combined with rising mortgage costs) the typical UK consumer faces the prospect of having less money left over for the fun things in life: holidays, clothes and consumer durables.

Economists use the ‘R’ word with caution: even talk of recession can be enough to dampen confidence, and slowdown and even declines in real incomes become reality.

For the UK, it’s all about the ‘D’ word now: demand.

Or should it be denial?