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Thursday, 15 September 2011 07:43

No Retail Therapy Likely For Sterling

In a parallel with the recent arrival of Hurricane Katia’s tail in the UK, Sterling has been caught in the back-draft of global market turbulence and weakened to an 8-month low against the dollar, but there has been no serious damage with Sterling not at the centre of the global economic storm. The latest retail sales data will be watched very closely and any monthly increase would provide initial relief. The risks are on the downside and a monthly drop of more than 1.0% would put Sterling under sustained pressure as recession talk would intensify with key GBP/USD support levels just above 1.54 coming into focus.

The UK is still benefitting from its position outside the Euro-zone as Euro fears intensify. There is a key advantage for Sterling as there is no realistic possibility of default given that it has independent monetary control. That faith in Sterling has been broadly maintained is illustrated by the fact that 10-year benchmark bond yields have fallen to record lows just above 2.2%. The decline in borrowing costs will also be very important in slowing the growth of debt as servicing costs are kept down.

Currency markets, however, are very harsh in their judgements and the pendulum can swing very rapidly against an individual country. Independence looks a lot less attractive if you attract unwelcome attention from the Hedge-fund bullies. The underlying UK debt dynamics remain precarious with the government debt/GDP ratio rising rapidly. If the economy heads back into recession, there will be a high risk of sovereign credit ratings downgrades and Sterling could quickly become a pariah in global markets.

This is certainly a realistic scenario from late 2011 when the economy will be under maximum pressure from international and domestic weakness. Debt concerns are then likely to increase rapidly, both for the private and government sectors, especially as tax receipts will be depressed and welfare spending will increase. Fears will be brought forward if there is a very weak reading for retail sales.

Anecdotal evidence suggests that underlying spending remains weak as consumer incomes remain under serious pressure. The British Retail Consortium also reported that sales had fallen 0.6% on a like-for like basis in the year to August. Underlying consumer spending has been weak, but for now it may still be predominantly be in areas which are not picked up by the retail sales data and the data is also always volatile on a monthly basis.

The housing sector will be important as large areas of consumer spending are linked to demand for housing. Given the very high level of consumer debt, any decline in house prices also has a crucial impact in weakening spending. The house-price evidence suggests that prices fell in August, again this is liable to have an important negative impact on fourth-quarter consumer spending.

There was certainly a sharp drop in sales in the London area at the peak of the recent riots and any weakness here will be seen in the August data. The national impact on the data should have been very limited.

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