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The Retail Forecast for 2016-2017
From the Centre for Retail Research
"It's time you were competitive like Britain, Osborne tells European elite"
(Quote from Rt Hon George Osborne, Chancellor of the Exchequer at Davos [Evans-Pritchard, 2015])
[this note prepared on 5 January 2016]
The Forecast for Economy and Retail
The forecast: the economic forecast suggests retail growth in 2016 should be 1.9% and 1.7% in 2017, on condition that the government does not make its economic policy any more restrictive than it is now. Although this forecast is slightly above that of several other forecasters we feel that spending related to increased wages, pension drawdowns, PPI and general consumer confidence will boost retail spending above what it would have been without these boosts. We also see the return of inflation in 2016, albeit in a mild form.
What does the near future look like? The UK economy, and with it the UK retail sector, has enjoyed uninterrupted growth since 2013, although growth fell from 2.6% a year in 2014 to an expected 2.3% pa in 2015. Favourable revisions of statistics by the ONS and new forecasts made in November 2015 by the Office for Budget Responsibility (OBR) improved the actual and likely outturn of the economy: the OBR stated that GDP was likely to grow by 2.4% in 2016 and perhaps as much as 2.5% in 2017 (OBR, 2015).
Yes, but. However there is plenty of evidence that the economy was slowing down in the later months of 2015. In December the ONS reduced its forecast of GDP growth for 2015 from 2.3% to 2.1% (Lynch and Prynne, 2015). Our view is that this may be a little harsh and we feel that 2.2% is more probable. This is slightly lower than the UK long-term rate of economic growth but it still rather better than our main European competitors.
The OBR's forecasts, which are used by the government, assume that the November 2015 growth rates (+/- 1%) will continue till at least 2020, although consumer spending will grow by around 0.2 percentage points less than this apart from 2016 when it is expected to average 2.6%.
How Uncertain Are These Forecasts?
How likely is this - or perhaps it would be better to frame it as how much uncertainty is there about these figures? The problem is that the OBR and the government assume that UK growth rates will continue to grow from 2013 without deviation from trend until at least the end of the decade. This has never happened before, certainly not since 1944. You may say, 'It'll all the different this time', but that was exactly what people said in the noughties when Chancellor Gordon Brown looked into distant years of future guaranteed growth and prosperity. In fact an editor of a refereed journal once told me that if he came across 'this is a new paradigm' in an article he immediately threw it into the bin.
The economy is already slowing down, although this could be temporary. The estimates done by the ONS tend to be less optimistic than the OBR. Its first estimate of quarterly growth is often revised upwards later on. That is why we can be slightly confident that the OBR's 2.1% for 2015 may not stand the test of time. But neither will the OBR forecasts either.
What can go wrong? Is there anything out there that might throw the UK economy off track? Or are we merely drear pessimists, the Presbyterians of retail forecasting? Our forecast of January 2015 suggested that the economy would start to slow down in the IVth quarter of 2015, which has indeed happened: but it has not ended growth although it may have cut consumer spending by around 0.1 to 0.2 percentage points.
One of the main problems is that in 2015, according to the OBR, 79% of all economic growth was caused by increased consumer spending (see Table 2 at the end of this piece), in other words we are back to having GDP driven by debts and shopping rather than by longer-term investment in roads, flood control, housing or manufacturing.
Surely, as Britain is doing so well, there are no forthcoming economic anxieties? Indeed, the main economic worries in the next two years involve such issues as: lack of growth in the Chinese economy (6% pa seems to be the current view, compared to around 10% annually in 2010), another Eurozone crisis, concern that Britain's leaving the EU will cause a financial crisis, the growing level of UK personal debt forcing the government to curb personal spending, and the growing adverse balance of trade (importing more than we import) producing a financial crisis. A single one of these factors would be manageable for the UK, probably: but two or more may mean that government economic policy has to go into reverse. These things are never predictable, but we think that 2017 will be a good year for things to go wrong. We are unconvinced by government economic forecasts that assume that the current benign economic circumstances will continue.
Potential Financial Crisis. The other problems relate to the British economy. The Chancellor tends to overhype how aggressive he is being about changing the UK economy. There is a real danger that he will not meet his target of controlling public spending. After all, his 2015 November forecast that public borrowing would be only £68.9 bn in 2015/16 was already broken four weeks later when it became clear that he had borrowed £66.9 bn in the first eight months of the year and he is unlikely to get away with borrowing only £2 bn to last the next four months. Once foreigners start to believe that the UK government is letting the economy get out of control, there is a real danger that further fiscal hardship will be introduced to as a means of 'restoring confidence' to overseas investors.
The Unwise General Election 2015. Most comment about the election focuses on such side issues as why the pollsters got it wrong, why Labour persevered with an unelectable leader, and dear oh dear what happened to the Liberal Democrats. There has been practically no discussion about whether the Conservatives were wise to promise no income tax changes, no VAT changes, no corporation tax changes, a shrinking public sector and a government financial surplus by 2020. From memory, there was no discussion in the election about how the Conservatives were to close the gap between exports and imports: there was certainly no declared objective about that one.
So we now have a government that apparently gave away all the main instruments of macro-economic control in order to win an election and whose policy is based on forecasts of 'uninterrupted growth'. Although media commentary about government policy consists of wonderment about its brilliant politics there has been less consideration about whether all this is good economics. It is not good economics. All the bad stuff is being stored up till later.
In the near term our view is that for retailing things should be all right, but 2017 is the year to watch. The government is also making some odd decisions, made without consulting expert opinion or interested parties. These may all blow up in their faces. Examples include: the introduction of the 'living wage', the 3% extra stamp duty on households that buy additional houses (aimed at buy-to-let), the tightening of the tax regime for buy-to-let landlords, the long-term impact of greater pensions freedom ('spend now, suffer later') and the effective ending of public rented housing and housing associations. This could all have been done so much better.
The Centre for Retail Research has no political opinions as such. It merely examines the impact of present and future government policy upon the retail sector.
The Economic Background in 2015
Figure 1 shows the change in growth (compared to the previous year). The sharp fall in the GDP caused by the 2008-2010 recession can be seen, along with the resumption of growth in 2010, when many thought the economy was still declining. This was followed by two years when the economy backtracked because the government tightened the screws too early and can be clearly seen in Figures 1 and 2. In 2014 the economy grew by its high point of 2.6%. GDP growth of 2.6%, whilst excellent in comparison to many other countries, is only our long-term average growth rate over the last 30 years: it is commendable, but not fabulous. The tailoff since 2014 with growth rates declining slightly is also shown.
Consumer confidence has risen steadily since 2013 and is now back to those happy days of the early noughties (Figure 2). This is a real change as the index has been negative for most of the last ten years
Figure 3 shows total GDP at constant prices (ie eliminating any inflation effect) between 2002 and 2015. It can be seen that rapid economic growth in the years before 2008 was followed by a big dip in GDP, the economy starting to grow again in mid-2009. It regained the previous peak GDP point of 2008 only in 2014.
So the country is now officially more prosperous than it was in 2008 and we can expect economic growth for at least another year or two - or to 2020-21 if you think the OBR has got it right.
Why has economic growth slowed in 2015? There are four main factors. The turmoil in the Chinese economy has had an impact on our own manufacturing industry and that of our trading partners (who also buy from us) such that UK manufacturing has contracted in the last few months rather than being able to take a larger share of UK GDP as the government once promised. Secondly, the slow growth of the Eurozone, and the depreciation of the euro, has reduced the sales of sterling goods and services overseas. Thirdly, government policy to reduce spending by local councils and government departments, however commendable, has also reduced incomes often by individuals with high propensities to spend their income.
However wages are improving, unemployment has fallen and many people feel like treating themselves - if only ever so slightly - after several years of anxiety.
Where is Investment-led growth?
Investment in infrastructure, investment goods for manufacturing and construction has not grown in the manner originally forecast by government experts and many high-ranking projects such as new nuclear power stations, a third runway at Heathrow (or not) and HS2 have not even started yet. Moreover, the Coalition Government started this decade by cancelling many investment and development projects which has led to a degree of underprovision. Figure 4 shows how business investment has fallen because of the recession and by the early 2020s will return, at best, to the 10% of GDP last seen in 2005.
Driving Retail Spending
Consumer expenditure is likely to have grown by 2.9% in 2015, but this should fall to 2.2% (our estimate) in 2016 and 2.0% in 2017. Some commentators feel that expenditure in 2016 will grow less than this as consumer indebtedness is already rising quickly. We do not disagree that this is a problem (see Figure 8), but feel that with consumer confidence high and higher average incomes, total consumer spending rose in 2015 and will continue into 2016.
Retail spending however has fluctuated considerably from month to month. Figure 5 shows that although retail spending had been a lot higher since 2013, there have been major spikes and troughs.
In 2014 and 2015 the weather has deviated from the normal standard: for example the warm autumn/winter in 2015 reduced sales of winter fashions. Retailers' changed attitudes towards pricing and promotions may also have affected spending patterns, where consumers may refrain from spending because they are waiting for the next bout of promotions. The so-called Black Friday effect (now a four-day or whole-week occasion at the end of November) is accused of reducing spending in October and early November because shoppers anticipate better deals around the Black Friday period as well as sucking Christmas trade from early December and the Christmas/Boxing Day Sales as well.
Shopping patterns have certainly changed since the recession, as consumers tend in general to buy rather less, to visit more stores and to buy an increasing proportion of their goods from discounters. This in turn may dampen seasonal patterns but may increase spending at times when popular retailers are at war with their competitors.
What Has Driven Retail Sales in the Last Two Years?
- PPI Windfalls. Spending may also have increased because of additional one-off sources of income which are treated as windfalls rather than as permanent income. The greatest example is mis-sold personal protection insurance (PPI), as a result of which financial institutions have reimbursed unfortunate (or, perhaps fortunate) claimants over a couple of years with more than £20 bn. No doubt some recipients will have put it in the bank or invested it wisely, but many will have spent it on a new kitchen, a better car, a trip abroad, or new coats, shoes, handbags or electronic equipment.
- Stable Prices. Stable prices in 2015 (prices rose by 0.1% only) may also have encouraged spending because it has the effect of increasing a household's purchasing power even if wages stay the same. The fall in petrol prices may have led some families to travel further by car, but the money saved by most households is most likely to have been spent on retail merchandise, entertainment or leisure.
- In 2016, price inflation is likely to return, but at the low rate of 1.3%. Petrol and diesel prices certainly will not return to their former levels until 2017 at the earliest.
- Wages. The outlook for wages seems rather better. Wages are already starting to rise and the governments adoption of what it terms the 'living wage' starting in 2016 has already led to actual or announced increases in wages for a proportion of the lowest-paid workers, although not the contract or self-employed sector where the lowest 25% are probably even worse off. Compared to the likely increases in the statutory Minimum Wage for 2016, the new 'Living Wage' is unlikely to have much effect on the number of workers or prices in the first year. However it may do so in 2017 and certainly will have a pronounced effect by 2019 on prices and the numbers employed.
So we can expect a further growth in consumption spending in 2016 as a result of wage increases and the Living Wage.
- Increased Household debt. Figure 6 shows that during the recession, households paid off their debts, saved more and cut spending so that in 2009/10 and 2010/11 they had a surplus of more than £60 billion. This pattern has been reversed and household debt is due to rise to more than £40 bn in 2015/16 and to exceed £50 bn in 2018/19 (Lynch and Prynne, 2015). The OBR originally forecast that we would return to the 2008 levels of indebtedness by 2020, although by November they suggested this was too pessimistic.
Source: independent 23 Dec 2015 http://www.independent.co.uk/news/uk/home-news/fears-of-new-economic-crash-as-british-families-run-40bn-deficit-a6782221.html
The Development of the Retail Sector
How will the growth forecasts affect the UK retail sector? In principle it looks as though for at least another year, retailers can look forward to uninterrupted growth after a savage period of falling demand and consumer change. However it is not as easy as that.
- Most of the growth in retail sales has gone online, meaning that the average bricks-and-mortar retailer has seen trade falling by between 1% and 3% every year since 2006.Online sales have risen by between 11% and 16% annually, compared to total retail sales growth of between -2.4% to +2.4% in the same period.
- Any growth that there has been is not spread equally amongst all retailers: the best retailers, such as discounters or high-end fashion or cosmetics have grown rapidly, leaving less sales available for everyone else.
Intense competition between physical and online retailers has reduced profit margins, so retail companies no longer have that cushion of fat which enabled them in the past to get though poor trading years.
- The traditional economic model of the retailer, either a central position in a high-rent store serving a discriminating and plentiful clientele or a smaller store in the suburbs or market town, paying less rent but knowing what customers wanted, is over. Occupancy cost is too high and UK business rates are the highest in Europe. Many retailers are low-wage employers and the living wage will put up their costs but more than they can put up prices. Many smaller stores are no longer able to attract sufficient paying customers, hence the large number of vacancies in many smaller towns and suburbs. The large supermarkets and DIY sheds are too big and no longer produce sufficient profit: many of their products (particularly online) are sold more cheaply online, and smaller and more agile discounters have shown how small supermarkets can outmanoeuvre the giant grocers. The end of the economies of scale and the economies of location will result in a fall in store numbers, as well the disappearance of many well-known names from the high street.
- Another factor at play is consumers diverting what would previously have been retail spending into spending on entertainment, restaurants, clubs, holidays and travel. Shopping now has to compete with other leisure spending, not always very successfully.
The growth of manufacturing industry to rebalance the economy was an early aim of the Coalition government, but so far it has been unsuccessful. It is important to note that sales of services, such as banking, finance, insurance, patent royalties, tourism are another source of 'exports' which have done rather better. Figure 7, which shows imports and exports in real terms (ie taking account of inflation), indicates that imports have stayed relatively level in the last few years whilst exports have risen (thus there has been an improvement in net trade) although this is expected to level out from 2016. Thus little or no export-led growth is expected and the high value of the pound makes further growth in exports difficult to achieve. The OBR forecast (Table 7) carefully shows that net trade will balance exports and imports, but all the risks are on the downside: ie there is a good chance that things will get worse not better. So much for export-led growth.
Housing as a Driver of Growth and Retail Spending
Housing is very important for the national economy. The country has too few houses which creates shortages of accommodation and inflates house prices. Building new houses is investment, creating incomes and benefits relating to actual goods and services. When people move they usually buy a range of retail products, including floorcoverings, curtains, paint, housewares, bed linen, furniture, cleaning products, electrical appliances, house security etc. It would help retailers if there were more houses built as well as stimulating demand. Table 8 shows that the OBR feels there is little prospect of that, with social housing completions forecast to be stable or declining and private sector housing rising from about 125,000 to only 158,000 pa in 2020. As a country we need about 200,000 houses to be built every year simply to meet new demand: to cope with the backlog we should built 400,000 for at least 10 years. There is absolutely no chance of this occurring. Although there are planning problems, brick capacity would need to double and we would need another 1 million bricklayers to be recruited and trained in order to do this. The construction industry could be built up to a decent size so it can build 200,000 to 400,000 houses but it would be about ten years before it achieved that sort of scale. Inevitably therefore pessimism is the order of the day.
What is Driving Economic Growth?
UK growth has not been led by renewed investment or by the growth in exports. However the consumer has stepped up to the crease and is starting to spend for England. As a short-term boost for the economy this would be worthwhile, but unless exports or manufacturing or investment rise then eventually economic policy will be used to restrain the economy (although the government promised to increase no major tax). Table 2, derived from the OBR (2015) estimates shows that growth in private consumption represented 79% of all contributions to growth.
Evans-Pritchard, A. (2015) "It's time you were competitive like Britain, Osborne tells European elite", Daily Telegraph, 24 Jan, p.39.
Gudgin, G., Couts, K., Gibson, N. and Buchanan, J. (2015) UK Economy Forecast Report, Centre for Business Research, Cambridge: University of Cambridge.
Lynch, R. and Prynne, J. (2015) 'UK growth estimate revised down in second blow for George Osborne',The Independent, 23 December
Office for Budget Responsibility (2015) Economic and Financial Outlook, November 2015, Presented to Parliament, CM 9153, London: OBR.