UK Retail Sales Fall More Than Expected in September, Complicating Bank of England's Rate Hike Outlook

What happened

UK retail sales fell by 0.4% month-on-month in September, exceeding the expected 0.1% decline. This contraction follows an upward revision to the August figure, which showed a 0.7% increase. Excluding autos and fuel, the drop was even more pronounced, at 0.7% in September. However, the quarterly picture still holds up reasonably well, with retail sales volumes rising by 0.7% in Q3 compared to the previous quarter. The weakness was broad-based, with supermarket sales declining after gains in the previous two months, and non-food store sales volumes falling by 0.4%. Clothing retailers also struggled, with unusually warm September weather weighing on demand for autumn and winter collections. There are signs that consumers are becoming more cautious, with some retailers pointing to lower footfall and customers cutting back on spending.

Why it matters

Retail sales data is a crucial indicator of consumer health and the broader economy. A larger-than-expected decline suggests that domestic demand may be weakening, which is a significant factor for the Bank of England's (BoE) monetary policy decisions. While inflation remains a concern, the slowdown in consumption, coupled with a labor market offering less reassurance, creates a dilemma for the BoE. The institution needs to balance the need to control inflation with the risk of excessively slowing down the economy.

Market impact

Interest rates and bonds: The fall in retail sales may reduce the likelihood of aggressive future rate hikes by the BoE, especially beyond November. This tends to put downward pressure on longer-dated gilt yields (UK government bonds) as investors may price in a less intense or shorter tightening cycle. Expectations for a November hike remain high (around 98%), but the probability of a December increase, previously at 45%, becomes less clear, now closer to a 'coin flip'. FX (GBP): The British pound (GBP) may face downward pressure against other currencies, such as the dollar, if weak consumption data is interpreted as a signal that the BoE will be less hawkish in the future. A less restrictive monetary policy tends to diminish a currency's appeal for yield-seeking investors. Equities: Shares of retail companies and consumer-sensitive sectors in the UK may be negatively impacted, reflecting concerns about falling sales. However, the prospect of lower interest rates in the long term could be seen as support for the broader stock market, although the immediate impact might be negative due to economic weakness. Brazil: Indirectly, a scenario of slower growth in the UK and a more cautious BoE monetary policy could contribute to a global environment of reduced risk appetite. This could lead to a flight to safety, potentially impacting the real and the Ibovespa, which tend to benefit from a more optimistic global outlook. However, the direct impact is limited, being more relevant for assets exposed to the UK.

What to watch

The next steps from the Bank of England will be crucial. It will be important to observe the tone of the BoE's communications in upcoming meetings, especially after the November decision. Inflation data, which remains persistent, and new reports on the labor market and consumer confidence will be key to confirming or invalidating the current reading of a slowing economy. Any signs of a recovery in consumption or an acceleration in inflation could alter monetary policy expectations.

Scenarios

Base case: The BoE raises interest rates in November but adopts a more cautious stance for December and beyond, with the possibility of a pause or a slower pace of increases, given the weakness in consumption. Longer-dated gilt yields stabilize or fall slightly, and the British pound trades with volatility. Risk scenario: Inflation surprises to the upside again, forcing the BoE to maintain an aggressive stance even with slowing consumption, which could lead to a deeper recession. Alternatively, consumption recovers unexpectedly, giving the BoE more room to tighten monetary policy. Original source: ForexLive (InvestingLive). For information only, not investment advice.