Economic View: Have a very wary Christmas

It was one of those deceptively simple questions that my colleague was asked: "Would the Bank of England like retailers to have a good or a bad Christmas?"

Behind it lies another question: whether the consumer boom is sustainable, or rather, whether the economy can continue to be supported by reasonably strong consumption until other forms of demand pick up alongside it. The Christmas shopping season matters hugely because it is disproportionately important in Britain; in the US it is more spread out, encompassing the Thanksgiving holiday too, while on the Continent, Christmas gifts are smaller relative to total spending.

The British shopping season has in any case changed quite markedly in the last few years. It has become more compressed, with people buying presents much later; and it has slithered over into January, with the prudent buying the big ticket items in the sales and giving a token gift on the day. There also seems to be some shift away from giving goods and towards giving, or at least spending money on, services. According to NOP, what are known as "socialising budgets" (not to be confused with "socialist budgets") are expected to be up nearly 20 per cent this Christmas. Meanwhile growth in retail sales last month was up only 2 per cent, the lowest year-on-year rate for two years.

So while the bars and restaurants may be pretty full, the shops may be rather empty. But from a macro-economic point of view it matters less whether people spend money on goods or services than whether we keep spending. Can we keep it up? Can the economy as a whole keep going?

The Bank of England published its latest Financial Stability Review on Thursday. It covers the whole world economy, but the chunk on British consumption concluded that, though Britons had greatly increased their borrowing, low interest rates meant the servicing costs of that debt were at normal historic levels. People would be vulnerable were there to be a sharp rise in rates or a large fall in household income. But it pointed out that the markets thought neither was very likely.

Some work by Goldman Sachs gives some modest comfort on this front. As you can see from the first graph (above, far left) the economy has become unbalanced, with consumption and government spending soaring and investment and exports falling. On the face of it, this looks rather alarming but there are a number of reasons why it is less so. As the Bank of England also pointed out, interest payments are low in relation to income (second graph), though house prices are now looking high on that measure. The Bank, of course, is also worried about the level of house prices.

But the consumer boom is not just the result of the borrowing boom. It has also been supported by an improvement in the UK's terms of trade. The goods and services we sell to other countries have tended to go up in price, while the goods and services we import have often come down. Products such as clothing and cars, of which we are net importers, are falling in price. This helps both at the national and at a personal level: we can buy more (ie increase our consumption) on the same income.

OK, so we have also cut our saving. But the fall in inflation has arguably reduced the need to save. Back in the 1980s we had to save just to stay in the same place because our money was losing value so quickly. The third graph shows how, if you adjust for this, our household saving ratio is higher than it was in the late 1980s and has recovered significantly since 1996.

Still not convinced? Try the final graph, which shows the proportion of our income that we have spent going right back to the mid-1950s. There was a long and sustained fall from then (when we did not save at all) through to 1980, a period that coincided with the great surge in inflation. By then we were spending less than 90 per cent of our income. Then came the late 1980s boom, when spending as a proportion of income rose again, followed by the early 1990s slump, when it fell back to the level of 1980. True, now we are spending more again, but only by comparison with recent history. Take a longer perspective and it appears we are still a more thrifty society than we were half a century ago.

Goldman's' conclusion is that growth in consumer spending will decline next year, as taxes rise, from its present year-on-year rate of 3.8 per cent to 2.7 per cent. But there won't be a sudden bust. If this prediction proves correct, then it believes UK interest rates have reached a trough. The next move will be up, not down.

What will Christmas tell us about this? My own guess is that it will be an OK Christmas from the sales point of view, but only an OK one. There is still some momentum left in the long consumer boom, but a lot of the spare cash will go on entertainment and not be spent in the shops. So retailers won't be thrilled. Shoppers will be particularly price sensitive, so if retailers get their prices wrong, people will wait for the sales.

Two things would really change the outlook. One would be a sharp crack in the housing market. Although the tone has already changed, particularly at the top end, the perception of change has yet to sink in. The other will be the response to the tax rises in April. That may prove a signal for people to draw back and rebuild savings more swiftly.

And what would the Bank of England want? I think it would like to see a quiet Christmas with consumers easing off a bit but still spending reasonably strongly. The one thing it would like to avoid is an early rise in interest rates to control consumption, before the rest of the world economy gets going again.