UK: It’s still spend, spend, spend but risks lie ahead - ING

James Smith, Economist at ING, notes that the UK retail sales surged by 2% in October as consumers continue to be fairly unfazed by Brexit. But the risk of falling real wages next year could dent spending and we think the Bank of England will cut rates again in 2017.

Key Quotes

“There are number of reasons why today’s figures are so strong (in fact, at 7.6% YoY ex. auto fuel, the strongest since 2002). Anecdotal evidence suggests that spending by foreign visitors has increased markedly given the weaker pound. Consumer confidence has remained fairly resilient, perhaps partly in response to the BoE’s swift actions back in August. But we also think there may be a statistical factor at play: retail sales has been particularly volatile for the past year, which leads us to take today’s figures with a certain pinch of salt.”

“But either way, the key point is that downside risks lie ahead. With inflation likely to soar in 2017 (we think CPI could hit 2% in the first half), real wages look set to start falling fairly rapidly. In the absence of a fuel price shock or VAT increase on the horizon, a full-scale return to the “cost of living crisis” of 2011 seems unlikely. But falling real wages, potentially higher unemployment (hiring surveys continue to paint a concerning picture) and possibly even some house price softness could be a major headwind to consumer spending and overall growth next year. After all, consumption has been the main (and sometimes the sole) driver of GDP growth over recent years.”

“Markets think there is a higher chance of a rate hike than a cut after June 2017. But given the downside risks to growth, we think markets are underpricing the risk of further Bank of England easing and we look for a 15bp rate cut in the first half of next year.”