What consumer problem?

With retailers' share prices falling after M&S's weak trading statement, and the BRC reporting slower sales growth yesterday, it's easy to think consumer spending will fall this year.  But in truth, there are good reasons why it might hold up well. Here are four:
1. Household finances are in decent shape. Their bank deposits grew 8.3% in the year to November, to £930bn (table A4.1 here). This is more than four times their non-mortgage debt, and is equivalent to over a year's disposable income.
2. Retail sales are at a record low relative to house prices. As common sense suggests this ratio should partly mean-revert (if it didn't we'd all end up as misers living in massively-priced homes), it points to sales rising relative to house prices. So perhaps consumers, showing the wisdom of crowds, are  preparing for a weak housing market. US spending has held up well so far despite the housing slump, so why shouldn't it do so in the UK?
3. The mortgage reset problem is overdone. Let's do a rough sum. Anyone who took out a two-year fixed rate mortgage in early 2006 faces a rise in mortgage rates of around 1.2 percentage points. With 1.4 million households due to refinance this year, this implies £2.5bn of extra mortgage payments a year, if we assume an average mortgage of £150,000. This is less than 0.3% of aggregate household income. 
4. Company profits are high. This matters,  because it means pressures on firms to cut jobs aren't especially severe. And if the labour market stays firm, so should spending.
Although these thoughts seem inconsistent with today's market opinion, they are in fact conventional among economists. The consensus forecast (pdf) is for household spending to grow 1.8 per cent this year. Though this would be its slowest rate since - well 2005 - it's hardly a catastrophe.
Does this mean retailers are moaning too much? Not necessarily. I suspect their problems this year will be not so much the aggregate volume of sales, but rather pressure on margins. Sterling's fall will raise the cost of some imported goods - adding to rising costs of rent and wages - whilst intense competition (caused in part by retailers' expansions of recent years) will make it hard to pass these increases on.

Comments

[tom s.]

"we'd all end up as misers living in massively-priced homes"

That's odd, because (like other UK emigrants to North America that I know) whenever I go back to the UK I think "this is a country of misers living in massively-priced homes".

[reason]

Not that I doubt the analysis, but a couple of quibbles.
1. Please, please, don't just look at aggregates, consider the distribution. A housing sale doesn't change the net asset/debt position (someone has just converted a house into cash) but it does change the distribution and distribution matters.
2. All the factors you mentioned (except the exchange rate) are domestic. The rest of the world matters.

[Jonathan]

On 4 (profits), two problems though: first, over the past 10-15 years the profit rates between tradables and non-tradables (at least as crudely proxied by manufacturing/services) have diverged from approximate parity in mid-90s. Aggregate profit rates are bouyed by returns in particular sectors and mask problems for tradable producers (as also reflected in the current account). Second, it is far from clear that historic relations of bouyant profits leading to investment (and then growth and employment) still hold as strongly.

[jameshigham]

It's quite simple - costs are way out of kilter with income. Credit is required to bridge the gap. This is wrong.

[Zorro]

Does inflation not matter to these equations? It's already running at over 5% (in real world terms), and the BoE is cutting interest rates in an attempt to keep the housing market going (because that is after all the only thing propping up our cyclopean economy). Fuel prices (partly due to wholesale prices and partly due to taxes) going through the roof, this will all cause positive feedback and push inflation higher and higher.

[john b]

@ James: PwC reckon that total non-mortgage consumer debt in the UK grew at 1.1% in nominal terms (PDF - see p4) in 2007 - i.e. it fell relative to incomes.

@ Zorro: according to National Statistics, who one might expect to know, RPI is 4.3% and RPIX is 3.2%. RPIX is the most relevant measure of what you're talking about, since it excludes mortgage interest payments which are almost entirely dependent on interest rates.

In other words, Chris is right [about this. However, he's wrong indeed to ban HTML comments from his blog and very very wrong to make it strip the links when it rejects the comments. They're below instead]

http://ukmediacentre.pwc.com/imagelibrary/downloadMedia.asp?MediaDetailsID=1035

http://www.statistics.gov.uk/cci/nugget.asp?id=19

[Zorro]

JB I can see where you are coming from but you and the office of national statistics are wrong. Why are /any/ figures excluded from the inflation figures 'becuase they are almost entirely dependent on interest rates.'?? Why does that matter. People have to pay for a roof over their heads. And council tax.

Any measure of inflation which specifically excludes something which is hightly inflationary and which every household in the country pays in one way or another is putting it simply, misleading. Putting it more honestly its called bullshit!

As I said before, real world inflation, ie inflation as it applies to real people living in this country is over 5%. That is what it is, regardless of what RPI, RPIX, CPI or any other acronym you can come up with is...

[john b]

But the difference between RPI and RPIX is *almost entirely due to* changes in interest rates.

RPI (and RPIX) compare prices in a given month with prices in the same month last year. The latest figures are for November 2007, which compare with November 2008. In November 2007, the base rate was 5.75%. In November 2006, it was 4.75%. That means that, assuming your mortgage lender passes on rate rises and cuts and that nothing else has changed, your mortgage payments will have risen by the same proportion in that year.

If interest rates remain static at 5.5%, that means that the gap between RPI and RPIX will fall from 100 basis points now, to 75 basis points by May, and then will be -25 basis points between July and December (i.e. RPI will be lower than RPIX) - purely because of the changing comparators.

In other words, mortgage costs do not represent a major inflationary threat and RPI is a misleading measure of inflation for forecasting purposes because it includes the effects of interest rate changes that have already happened.

(the above assumes the change in outstanding mortgage balances is not significant, which is accurate enough for this kind of back-of-envelope working out).

[Zorro]

I think I understand what you are saying JB but from from the point of view of a member of the public, ie me, real life inflation is more than 5%.

I'm not talking about inflation 'for forecasting purposes', I'm talking about inflation in terms of how it affects me and my monthly costs.

My costs are going up at more than 5% per year, therefore real life inflation, for me (and a lot of the public), is more than 5%.

It doesn't matter to me /why/, it just matters what it actually is, and I can tell you that real inflation is more than 5%.

Anything else is simple the govt cooking the books. (Which is not something I put down exclusively to the Labour party, much as I loathe and detest them - I mean govts in general).

[Alex]

Otherwise, putting up the interest rate to reduce inflation would make the apparent rate of inflation go up.

[hjg]

idiot.