Retail Forecast for 2007

From Professor Joshua Bamfield,
Centre for Retail Research. (February 2007)

Forecast for 2007

A tough year for retail businesses with much competitive pressure particularly from supermarkets.

  • Higher sales growth than 2006 - around 0.2%-0.5% more than 2006.
  • The 2007 growth outturn is expected to be 3.4% -3.7% (we think the 2006 outturn was actually 3.2% [less than the Office for National Statistics]).
  • Retail price inflation will rise slightly to 0.7% in 2007.
  • Christmas should be 5% up on 2006.

At least two more interest rate rises above the 5.25% of January '07. We do not see interest rates starting to fall till the very end of the year, if that.

The retail industry exists to sell people things that they need physically or which make them feel better about themselves or more successful or more attractive to others (or all four). We feel that consumers are fairly negative about themselves and others and about their financial assets. Moreover the retail offer is unexciting: shops and stores will need to work hard to excite customers to part with more of their cash.

GENERAL BACKGROUND

How have we got here 2004-6?

After 2001, retail spending by consumers was satisfactory - that is until the Bank of England increased interest rates and changed the economic climate. Up to this time, economic growth had been generated mainly by consumer spending, much of which was linked to borrowing and the house-price boom. Buoyant house prices enabled households to dissave and to increase their consumer spending through re-mortgaging their main asset. Industrial employment continued to decline. The increased interest rates of 2004 slowed down the housing boom, changed consumer expectations, and started the process of rebuilding household financial assets. The growth in retail spending fell, as the Table below shows. As a result, retail sales in the second half of 2004 and most of 2005 were weak. 2006 was better, but after a reasonable first half year, retail sales were patchy (see Table), one good month being followed by a bad month. Pessimism was the order of the day.

What happened in Christmas 2006?

By October 2006, footfall was 5% down on 2005 (which had been a very bad year). The KPMG /SPSL Retail Think Tank was predicting a poor final quarter overall but it thought Christmas would (probably) be slightly better than 2005. People were so gloomy by early November that Seymour-Pierce's Richard Ratner declared that Christmas 2006 could be 'the worst for 25 years'.

In the event, December sales rose 1.1 percent on the month, the highest monthly rise since June 2005, and the best December for three years. This was more than double what most analysts had predicted. It meant that the annual retail sales growth in 2006 was 3.7 percent.

Was Christmas true?

There was some evidence of shoppers saying 'Sod it, let's have a good Christmas!', but this alone does not explain what happened. The UK Office for National Statistics (ONS) stated that robust sales were achieved without retailers having to cut prices. It stated that prices were 0.2 percent higher in December 2006 than the year before, the fourth consecutive monthly increase and the longest run of rises since April 1999.

In fact the ONS cannot know this and we expect the December 2006 and January 2007 figures to be revised downwards in three month's time. In the weeks up to Christmas, many retailers cut prices, put on special offers, and used vouchers and electronic vouchers and codes to cut their prices to selected customers to stimulate extra business. Some even started their sales early, including those that had declared 'No, we never do that!' It is undeniable that the general air of pessimism around in November (including the Ratner effect) did make lots of CEOs jump and forced them to do everything possible to boost sales.

We also feel that the ONS may not measure the differential impact of Christmas: it may capture the results of successful retailers but may not be so good where the poor performers are concerned.

So we do not think that Christmas 2006 was as wonderful as the ONS (and we are unhappy about the '3.7% growth' estimate), but we agree it was a lot better for most retailers than 2005. Our own estimate for 2006 is 3.2%.

2007 Forecast for UK retailing

Retail inflation:
Inflation in the prices of retail goods has been low since 2001, and considerably lower than price increases in the rest of the economy. The UK Consumer Price Index (CPI) has exceeded the Government/Bank 2% target for most of 2006 and reached 3% in December 2007. But heavy competition in the retail sector, the shift of supplies towards Asia, and sterling currency appreciation has kept retail inflation low. We believe that retail inflation in 2006 was 0.5% and we expect it to be around 0.7% in 2007.

Increase in retail volumes:
Allowing for inflation, the increase in retail volumes (real terms) was around 2.7% in 2006. In 2007, we expect there to be a real increase again in 2007 in the range of 2.7%-3.0%.

General Outlook for Retailing and the Economy
We believe that economic forces are moderately benign in the UK and the key factor affecting retail sales is likely to be interest rates. The Bank is keen to curb consumer spending and the housing market without prompting a recession (successfully so far) and the main worry will be the Bank's need to increase interest rates into the second half of 2007 if inflation does not subside. We also feel that UK consumers are rather negative: shocks such as oil-price surges, a new war, a stock market slump or correction, or a sustained terrorist campaign will worsen sentiment and keep people away from shopping centres, particularly central London.

Mildly favourable factors for retailers:

  • Downward petrol prices: petrol prices have increased costs for businesses and consumers both directly at the pump and indirectly through fuel utility bills. Since last summer, crude oil has fallen from $78 per barrel to $55 and petrol prices from almost 100p to 85p-86p per litre. Unwinding cost inflation in this way provides a stimulus to the economy and supports retail spending.
  • Stable Taxes: the current Chancellor has been extraordinarily fortunate in his economic forecasts. Often heavily derided at the time (particularly in 2005-6) his record has been better than any other analyst. So we are not, this time, expecting any major unforseen tax rise. If, however, the new Prime Minister, Gordon Brown, calls a snap General Election in October 2007 (only likely if the Conservatives make some key errors), we would expect this to be followed by a tighter fiscal rein whoever wins.
  • Wage increases: by October 2006, wages were rising at 3.8% pa. The Government wishes to curb public sector pay to an average increase of 2%. We expect final pay settlements to be in the 2.80%-3.2% range, and this is one of the reasons why we expect more than one further increase in interest rates.
  • Retail's share of the household budget: we feel monetary and fiscal tightness may be some beneficial impact on retailers because price competition makes retail goods relatively cheaper compared to holidays, air travel, eating-out, house purchase etc (which are all rising in price) so retail goods may supplant non-retail purchases to a small extent.
  • The internet: is still only around 3.5% of retail sales (the 10% figure often quoted includes non-retail things like insurance and ticket sales), but consumers feel increasingly positive about it as a source of information and supply. Most large retailers are multi-channel now so, other things being equal, may benefit from further internet growth.

Moderately unfavourable factors for retailers:

  • Rising interest rates: after the January '07 shock increase in interest rates, City analysts have become quite complacent - one more rise, then perhaps an interest rate fall in the second half of 2007. We feel the Bank is anxious not to create a recession, but nevertheless the economy is very buoyant and that two more interest rate rises before June 2007 should be expected. We do not think rates will start to fall till very late 2007 at the earliest and it is possible that they may be higher by December 2007 than in February 2007.
  • Higher supply prices: one reason why UK retail prices can be so low is the shift of production towards China. We feel that China is now suffering from supply-side problems including labour shortages, which make it difficult to achieve further price improvements from goods manufactured there. Sterling should depreciate by 4%-8% (in spite of interest rates) and this will also make the import prices of retail trades goods higher.
  • House prices: we are back to a two-nation country with booming prosperity, shortages, and laughably high house prices in the South-East, and a more difficult situation in the regions. Cheap houses (below £0.2 million) are selling well, but there is practically a housing recession north of Milton Keynes and west of Swindon. In January 2007 there were signs that the housing market was slowing down rapidly, but much will depend on the May '07 figures.
  • Personal indebtedness: irrespective of the shrieks of horror about the large number of IVAs, we feel that the level of personal indebtedness is much less of a problem in 2007 than in 2005 or '06. It is true that banks are now discovering the true cost of unrestricted borrowing, but the problems of 2003 to 2005 are now coming to light, bad debts are heavily lagged). In most months of 2006, consumers made net repayments of their credit card debt, creating the first annual reduction in plastic card debt since 1994. The household savings ratio has increased from an historic low of 3.7% in 2003 to 5.3% in 2005 and possibly 5.1% in 2006 (our estimate), but is still well below the 9.1% average of 1990-1999. We think there will still be millions of people who want to cut their debts/ increase savings (particularly with high interest rates) and this will dampen retail sales growth. If the economy moves into recession, expect this effect to be very significant.
  • An unexciting retail offer: basically, shops, whether high street or out-of-town, are boring, unstimulating, and unexciting. Where is the new (fashion) Look, the new hemline, electronic equipment, new films, new home improvement format or leisure destinations to stimulate a jaded public? Well there is excitement around plasma TVs, mobiles, and wireless boxes! Which retailer will provide the new brilliant innovative WOW!-factor retail format for 2007? Retailing is efficient but not very wonderful and some of the most innovative things are now occurring 'off-retail', such as broadband connections, You Tube, home automation, software, song and film downloads, and a mobile-phone centred life (including contactless payment systems). Everybody's done it, from decking in the back garden to Nigella's cooking.
  • Customer behaviour: lacking in 'animal spirits': we are also pessimistic longer-term about retail spending because we think people are negative, they have low expectations of the future, their view of their long-term net incomes is low, and their financial portfolios (including current-account balances and savings) are low in comparison to their current or long-term incomes (eg against the late 90s or even 2000). We expect them to attempt to rebuild their financial portfolios over the next three years bringing the ratings ratio to around 7.0% to 7.5%, but we do not expect them to be very consistent about this. However it will soften spending.

The Kafka Factor ©: all economists tend to be pessimistic as all psychologists tend to be clinically insane. The Kafka Factor has been developed by the Centre for Retail Research to enable the non-specialist reader to make allowances for the approach of the forecaster. We define the Kafka Factor as a measure of the willingness of an economist/analyst to interpret any given flow of economic data negatively. The scale is from 1 to 10, where 1 is relentlessly optimistic and 10 is pessimistic. A 'normal' score would be between 4 and 6. The Centre for Retail Research is probably a 6, Hyman is 5 and Ratner used to be a 3 but is currently a 9.

The Kafka Factor draws on an important insight from the University of Oxford. The Black Correction Factor was an allowance made concerning economics examination marking. Dr Black, a well-known and fashionable economist, was a tough marker always one grade below most other markers. As soon as the statistical reliability of this difference was appreciated, agreeing final examination marks was easy, saving much discussion time for all examiners.

JANB - 14 February 2007