There have been alarms put round that the UK will witness a big squeeze on real incomes, leading to a reduction in consumer demand. The argument goes that the devaluation of the pound will cause substantial price increase, which will eat into wage increases and cause a fall in real incomes and spending power.
The latest official figures put out by the Office of Budget Responsibility (OBR) do not back that judgement. They show real incomes rising every year for the next five years. They do, however, show only a tiny increase of 0.1% in real disposable household income next year, as they expect RPI inflation to hit 3.2% whilst wages and salaries only go up by 2.7%. Tax cuts for the lower paid help, and the new Universal credit is designed to make it more worthwhile to work. Thereafter the OBR sees an acceleration in real disposable income, reaching an annual growth rate of 1.9% by 2021.
Household consumption shows a positive growth rate throughout the period, with a low of 1.1% growth in 2018. We think these figures from the OBR are on the low side for 2017. It looks as if the economy can continue to grow as this year at 2% or better. The Bank of England and Treasury have had to revise their more pessimistic post referendum forecasts for the current year back up. The main reason has been the continuing resilience of the UK consumer, and buoyancy of retail sales. These hit the remarkable growth rate of 7.1% in volume terms this October compared to October 2015. We would be surprised if this rate of growth continued, but we do not expect retail sales to turn negative or for the real income squeeze to be as tight as some forecasts are suggesting. Money and credit growth has also speeded up, and continues at a pace capable of generating reasonable growth.
One of the reasons to be a bit more optimistic is the performance of retail prices so far. The pound has been falling for a year, yet this October retail prices were still below the level of a year earlier. So far the retail industry has absorbed all the fall in the pound. There is plenty of capacity worldwide to choose from when buying goods. Internet retail competition is keeping prices and margins down, as is discount competition from the likes of Aldi. It is true some of the protection from forward currency cover will expire and all of the advantage of old contract prices will run off, but the world will still be very competitive and keen to sell. It seems quite likely it will take longer to see the impact and less of the pound effect will come through than some fear.
It is also possible that the pound recovers a bit over the year ahead. We have seen a sharp revaluation of sterling against the euro and the yen in recent weeks, disguised by the strength of the dollar which is the rate UK commentators seem to study most. It is possible there can be more import substitution to keep costs down. It is also likely, as the OBR themselves suggest, that pay and earnings will move upwards more quickly in the years ahead. The OBR estimates wages and salaries growing by more than 4% from 2020, and average earnings going above 3% growth in 2019.
We think some of the forecasts are too low. Whilst there will be some upturn in inflation, the general trend of real incomes will be upwards. The consumer may calm a little after the enthusiasm of shopping this autumn, but we still expect positive numbers. This does not necessarily translate into great news for retail companies, as they will need to continue to promote, price cut and squeeze their margins to chase the marginal and discerning extra pounds of retail spend.
The above article by John Redwood, Charles Stanley’s Chief Global Economist, was first published by Charles Stanley on 25th November 2016.