UK consumption stalling as BoE's interest rate medicine starts to bite

Disappointing retail sales numbers from the UK this morning, the headline monthly rate for October falling by -0.3% and September’s reading revised lower from -0.9% to -1.1%. The picture clearly emerging is one of consumer spending stalling. With domestic consumption so important as a driver of UK growth, the fact that the economy has so far managed to avoid tipping into a recession has largely been attibuted to the unexpected strength that has been seen in consumer demand. However, today’s numbers suggest that this strength is finally wilting as the cost of living crisis and the impact of the BoE’s interest rate hikes start to strangle economic activity.

On a value basis sales actually rose by 0.1%, highlighting how consumers are paying more for a smaller basket of goods. And with the fall in sales today seen across nearly all retail sectors, the fear will be that consumers are no longer trying to maintain consumption patterns but are finally succumbing to the financial squeeze being applied to them. For retailers this could not be coming at a worse time, as we are now at the start of the key Christmas trading season when most stores expect to make the majority of their annual profits. Although wages are finally starting to rise faster than CPI, this boost to real incomes may not be enough to encourage consumers to spend more, particularly in the face of rising mortgage costs and a weakening jobs outlook, leaving many retailers facing an uncertain future.

However, it is not all bad news. A key factor behind the poor October number is being laid at the door of the wet weather seen in the second half of the month, which discouraged consumers from venturing out to shops and malls. This was likely the key reason for non-food sales falling by 0.2% on the month, with spending on clothes falling by 0.9% and on household goods by 1.1%. And looking forward, as wages growth continues to exceed CPI, the boost to real incomes this provides can be expected to generate at least some additional consumption: the key issue here is how much of this additional money households choose to spend as opposed to save, in the face of rising mortgage costs and a slackening labour market. But while job security is expected to continue to diminish going forward, the outlook on the mortgage front is not so downbeat. An expected decline in the number of mortgages maturing next year, coupled with mortgage rates that are already starting to ease, will translate into the interest cost of the total mortgage stock consuming a smaller additional share of aggregate disposable income in 2024 than it has done in 2023. But nevertheless, this still represents an increased pressure on household budgets.

But whatever gloss you try to put on things going forward, today’s numbers will stoke further fears about the likelihood of the UK economy tipping into recession, something the BoE has already attached a 50/50 risk to. And it has seen market expectations of BoE policy move to, from 19bps of cuts expected by end-June immediately following the 2 November MPC meeting, to some 36bps of cuts now being expected by the same date. Clearly the BoE’s mantra of “higher for longer” is starting to be questioned by the market, and as growth weakens, so the door for an earlier rate cut will be opened increasingly wide.