Hamish McRae: Falling retail sales are bad news for the economy, and for the Chancellor's face
Sunday 23 October 2005
The economy is still growing slowly, but retail sales are only just rising and the Government's finances remain under pressure. A lot of new information about the UK economy came out last week giving a mixed but, on balance, somewhat disturbing message.
The reasonable news was that the economy continued to expand during the three months to the end of September. Growth was just 0.4 per cent, so that the annual rate would be a little under 2 per cent. You can read this in two ways: on one hand, the terrorist attacks in London do not seem to have caused any general economic disruption. On the other, growth remains the slowest it has been since the early 1990s.
Over the past 12 months, the economy has grown at 1.6 per cent and the outcome for this calendar year will be somewhere around that too. That compares with a Budget forecast of 3 to 3.5 per cent, recently revised down to 2 to 2.5 per cent.
The high street is feeling the slow-down most severely. Retail sales grew in volume terms at 0.7 per cent in the year to September, but prices are falling by 0.9 per cent a year, so the actual cash taken by retailers is down. Prices in the shops have been flat or falling since the middle of 1999 but, until recently, retailers have seen a large enough increase in the volume of sales to more than offset any falls in price. Now they are caught in a double bind. Retail sales volume growth for the past three months is now the lowest, compared to similar periods, since 1996.
We don't only spend money in the shops, of course: we spend in bars and petrol stations too, and increasingly on-line. Retail sales account for only about one third of consumption. Still, flat sales are a measure of people's new caution.
Slower growth in the economy has not, as yet, undermined employment; unemployment is creeping up, but employment is still rising. The workforce has grown significantly in the past year, about half of it apparently accounted for by immigration from Eastern Europe. Thanks to this, and to the higher oil price, tax receipts have not been too bad - or rather, they have not been as bad as one might have expected given the fact that the economy is growing at only half the pace expected by the Treasury in the Budget. But they have not been too good.
So far this financial year, the public sector has borrowed just under £25bn - that is its net cash requirement. For the year as a whole - that is to next April - it is supposed to borrow only (only!) £35bn. Most City commentators reckon it will overshoot by £2bn-£5bn. Barclays Capital, for example, reckons on £37bn. The deficit does seem pretty stuck at close to £40bn, as the left-hand graph shows.
It is hard to see clearly quite how serious the shortfall is. To some extent, the problem is higher-than-expected spending, but this may just be departments bringing forward planned spending. The "got to spend it now or it may be taken away" mentality will be immediately recognised by anyone familiar with the public sector. Growth in spending is now running at 7 per cent a year on a three-monthly basis, instead of the planned increase of 5.6 per cent, so there may have to be a winter clampdown.
But at least the Government can control its spending. It has less control over its revenues. Some forms of tax seem to be bringing in the bacon fine. But income tax has been disappointing. Last month, revenues were down year-on-year. That may simply be a bad month, but on a three-monthly basis income tax revenue is only up 1.7 per cent on the previous year. We are not yet back to the negative territory of 2002 and 2003, when income tax receipts were stagnant or falling (see right-hand graph). But the very good tax receipts of last year seem to have been a flash in the pan.
My own reading of this is that the worry is not so much this year but rather the next, and the years beyond that. The Chancellor will be embarrassed, insofar as that is in his nature, by missing his pre-election growth forecast by such a big margin. But he can just about maintain that he is still within his own golden rule of borrowing only for investment over the economic cycle. The problem, in any case, is not what happens in any one particular year but, rather, what happens over a longer period. The truth is that the country is stuck with a deficit of a little over 3 per cent of GDP and the Chancellor can do little about it.
That seems to me to be the big reality we have to face. We are not in as big a fiscal bind as we were in the early 1990s, when the absolute size of the deficit was as large as it is now but relative to the economy was much larger. But that deficit ought to have been coming down over the past two or three years of strong growth, as each year the Treasury forecast, and it hasn't.
There may be worse to come. Next year sees a huge reform of private pension provision. At the moment, the amount people can save in a pension each year, before tax, is limited, though there is no overall cap on the size of the pot.
From next April, the annual limit will be £215,000 up to a cap of £1.5m. In practice, this may lead to a surge in savings for retirement, which is fine, but it may have a much more dramatic impact on income tax revenues than the Chancellor expects. Since income tax revenues are already weak, and since high earners pay most of the tax, revenues may well dip back into negative territory. What then?
Virtually all the professionals think that tax rates will have to rise and they expect this irrespective of any unexpected shortfall in income tax. But tax rises next year would hit an economy that is already slowing.
Maybe the Chancellor can push troubles forward for yet another year. That is what France, Germany and Italy have done, sticking with their deficits above or close to 3 per cent of GDP. (Though Germany has just postponed a cut in corporation tax by one year because of the need for revenues.) But sooner or later either revenues have to rise or public spending has to be cut.
The big point here is that, from now on, financial pressure will give a new tone to the whole business of government. Instead of there being a general feeling that there is money around, there will be a new and cooler mood. It will mirror the new and cooler mood in the high street. And this shift will take place even if overall growth in the economy continues: not an obvious disaster, just a change of tune.
Through the woods, but no bear in sight
In case you hadn't noticed, shares around the world have been very weak for the past month - reminding us that share crashes always seem to come in October. The MSI world index is down 5 per cent, we are down almost 6 per cent, the eurozone is down 4.4 per cent, the American Standard &Poor's 4.1 per cent and emerging markets more than 8 per cent.
When you get a sell-off such as this the obvious question is whether this is a useful buying opportunity or a harbinger of something worse to come. In the past couple of days several commentators have come out with a positive view. For example Chris Watling at Longview Economics argues that among other "buy" signals the equity-risk premium is now at the highest level for 20 years. Goldman Sachs points out that its global lead indicator points to a continued steady upswing in world economic activity. Standard Life thinks that this is a mini-cycle within a broader uptrend. John Calverly at American Express says "no need to panic". And so on.
So the consensus is unusually clear. Perhaps unsurprisingly I could not find a single specific bear note on the markets last week - though Smithers & Co has been consistently arguing for some time that world equities are overvalued. But the most important question is the one posed by Chris Watling: what could go wrong?
He gives three answers. One is that market volatility will rise - that is, shares will become inherently riskier. A second is that equities are clearly overvalued. And a third is that there is a slowdown in company earnings growth. But he reckons that all three are unlikely.
My own feeling is simply that the markets got too carried away a month ago. They were faced with rising American interest rates, rising American inflation and much higher-than-expected oil prices. These make a pretty toxic mixture but the markets ignored them. So what has happened is just an adjustment to previously known concerns - a "correction". But October is a tricky month and we are not through it yet.
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