Feeling the chill
It’s been a long, cold winter on the UK high street, with household names closing branches and some ceasing trading completely.
The “Beast from the East” put people off shopping contributing to March’s drop in retail sales. However, while the weather has not helped the high street’s woes, the twin culprits of online shopping and weak spending power have arguably weighed more heavily.
The shift to online shopping isn’t going away anytime soon. But on the spending front, there may be some hope.
A change in the weather
UK consumers have felt the pinch as inflation remained stubbornly above wage growth — meaning living standards and disposable incomes had been falling until very recently. But a further improvement looks likely to come sooner than many expect.
Wage growth is now picking up and, with UK unemployment at the lowest level since 1975 [Source: Bloomberg as at 02.05.18], wages could well be rising by over 3% by the end of the year. The even bigger positive is that inflation looks set to continue falling—and at a faster pace than many forecasts suggest.
The rally in the pound since the start of 2017 means the cost of imported goods could switch quite quickly from being a significant contributor to inflation to a downward drag on prices. If sterling’s recovery causes price pressure to recede as quickly as we expect, consumer price inflation could be back at or even below the 2% target by the end of the year.
Sunnier times ahead?
Lower inflation combined with higher pay makes consumers feel better off—as evidenced in the strong historical correlation between real wage growth and consumer confidence. The recent small improvement in consumer confidence could be just the start of a more significant improvement over the rest of the year.
Unsurprisingly, consumer confidence has historically been strongly correlated with retail sales. If we’re right in our assessment that inflation will continue to fall quickly, with real wages rising and consumer confidence increasing, retail sales could see a marked improvement—one that is not currently priced into stock markets.
A decline in inflation could benefit consumers in another way: through interest rates. The market is currently uncertain whether we’ll see one or two rate rises this year. If inflation falls faster than the Bank of England (BOE) expects, only one of these potential increases might materialise, keeping borrowing costs low for UK households, with further positive implications for spending.
By the end of the year, the current pessimism about the UK high street might seem excessive. While some of the challenges that face the nation’s retailers reflect structural shifts in spending behaviour, the outlook may not be as bleak as it appeared in the depths of winter.
Mike Bell is a Market Strategist. Read more about J.P. Morgan Asset Management’s UK equity fund range >