Economic Outlook – UK

Some welcome good news for the UK’s AAA-rated economy is expected to come from CPI dropping markedly to a 9-month low of 4.1% in December from 4.8% in November. In addition, retail sales are anticipated to have seen decent overall volume growth during December following a ‘late rush’ to buy Christmas presents and to take advantage of the best of the clearance sales. Nevertheless, the retail sales deflator is likely to highlight the fact that sales were lifted by markedly increased and earlier discounting, which will have hit retailers’ margins. Meanwhile, unemployment is likely to have risen further, particularly on the International Labour Organization measure, with earnings growth remaining muted.

Data out on Tuesday are expected to show that CPI retreated markedly to a 9-month low of 4.1% in December from 4.8% in November and a 3-year high of 5.2% in September. Core CPI is seen moderating to 2.8% in December from 3.2% in November and 3.4% in October. Inflation is expected to have fallen markedly in December as a result of earlier and increased discounting by retailers trying to get pressurized and worried consumers to part with their cash over the critical Christmas period. In addition, base effects should be favourable, as consumer prices rose by a sharp 1.0% m/m in December 2010, as a result of sharply rising oil and commodity prices and some retailers seemingly putting up prices ahead of the January 2011, VAT hike from 17.5% to 20.0%.

Belief that consumer price inflation fell back sharply in December is supported by the British Retail Consortium reporting that annual shop price inflation moderated to a 16-month low of 1.7% in December from 2.0% in November and a peak of 2.7% in both September and August. The y/y increase in non-food prices fell to a 2-year low of just 0.3% in December from 0.8% in November and a peak of 1.4% in August. Annual food price inflation edged back up to 4.2% in December from 4.0% in November, but it remains appreciably down from the 5.0% peak in both September and August. Consumer price inflation should dip sharply in January and could be down ‘near’ 3.5% as the impact of the January 2011 VAT hike from 17.5% to 20% drops out. It should then head down markedly further due to the waning impact from substantially rising energy, commodity, and food prices in late 2010 and early 2011, and from GBP’s marked depreciation. In addition, weakened economic activity and ongoing muted wage growth amid significant (and growing) labour market slack is expected to weigh on underlying inflationary pressures. We suspect that CPI could fall below 3.0% in Q2 and be down to the Bank England’s target level of 2.0% by the end of 2012.

Labour market data on Wednesday are likely to show further weakness, thereby extending recent, largely worrying developments. Claimant count unemployment is forecast to have risen by 10,000 in December, which would be up from increases of 3,000 in November and 2,500 in October. This would be a tenth successive increase and take the number of claimant count unemployed up to a 24-month high of 1.6086m in December from a 24-month low of 1.4498m in February 2011. Claimant count unemployment was pushed up earlier in 2011 by changes to the benefits system, as well as by muted economic activity. The claimant count unemployment rate is expected to have climbed to 5.1% in December from 5.0% in November, 4.9% in August, and a low of 4.5% in the five months through to March 2011.

Meanwhile, the number of jobless on the ILO measure is seen rising by around 95,000 in the 3 months to November to reach a 17-year high of 2.661m. This would see the ILO unemployment rate climb to 8.4%. ILO data are also likely to show that employment was essentially flat in the 3 months to November at 29.10m. Employment peaked at 29.279m in the 3 months to May 2011, which was the highest level since end-2008. Persistent economic weakness, lower business confidence, and mounting public-sector job cuts are combining to take a serious toll on jobs. We suspect that the economy was essentially stagnant in Q4 and we expect it to contract in the early months of 2012 before stabilizing towards midyear and returning to modest growth in 2H. Consequently, we expect the number of jobless on the ILO measure to reach a peak around 2.85m in the latter months of 2012, which would see the unemployment rate climb close to 9.0%; however, there is a mounting risk that unemployment could rise even higher than 2.85m and not start falling before 2013.

Retail sales volumes (out Thursday) are expected to have risen by a decent 0.7% m/m in December after a drop of 0.4% in November. This would see the y/y increase in retail sales volumes climb to 2.5% in December from just 0.7% in November. Survey evidence from the British Retail Consortium indicates that total sales values rose by 4.1% y/y in December following an increase of 0.7% y/y in November. Meanwhile, sales values on a like-for-like basis (which strips out the effect of additional floor space) grew 2.2% y/y in December following a drop of 1.6% y/y in November. While the BRC acknowledged that December sales were better than hoped for, they highlighted the fact that the performance was boosted by a number of factors. First, the y/y comparison was lifted by sales being significantly restricted overall in December 2010, by heavy snow. In addition, shopping days fell kindly in 2011, with Christmas Eve falling on a Saturday. Furthermore, many shops stayed open for longer hours.

Most significantly, retail sales were clearly lifted in December by many shops engaging in earlier and heavier discounting as they tried to entice financially squeezed and worried consumers to part with their cash over the critical Christmas period. This will have lifted sales at the expense of retailers’ margins. This increased, and earlier discounting is likely to be reflected in a further marked fall in the year-on-year increase in the retail sales deflator after it retreated to an 11-month low of 3.6% in November from 4.2% in October and a peak of 5.2% in August. It is also likely that retail sales were lifted in December by many consumers seeking to take advantage of genuine major bargains in the post-Christmas sales that they cannot otherwise afford at the moment. Having said that, we suspect that interest in sales could decline pretty quickly once the best of the bargains are gone. Given low confidence and squeezed finances, we suspect that people will generally be more careful in buying-or more reluctant to buy-items they do not really want or need in the sales. It is also notable that the BRC commented that “post Christmas offers brought large numbers of shoppers out but that was generally a short lived hunt for bargains.”

Decent retail sales growth in December would significantly boost hopes that the economy avoided contracting in Q4; however, the worry is that after a flurry of activity in late December, financially stretched and worried consumers will quickly put away their wallets or purses and retrench. This could weigh down heavily on consumer spending in the early months of 2012, at least and increase the risk that the economy could contract in Q1.

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