Economic Forecast for Retail for 2008 to 2009

Economic Forecast for Retail for 2008 to 2009

'Hard pounding, Gentlemen'

An Economic Analysis and Forecast for the Retail Sector
from the Centre for Retail Research

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The Main Questions
Most UK comment in any information medium about our economic prospects seems to boil down to, 'You're all doomed, doomed I tell ye'.

As economic analysis this lacks analytical rigour, but perhaps shows why the index of consumer confidence has fallen from 93 points (June 2007) to 61 in June 2008.

Are things bad? Yes. Are things going to get worse? Yes.

What people really want to know is:

'How bad will things get?' and

'When will things start improving?'

'What will this mean for the retail sector?'

That is what this paper is about. We avoid much economic jargon and graphs.

There is no reference in this paper to 'the Credit Crunch', which is, after all, a tired and vacuous concept. We make no reference either to 'stagflation', a concept that is currently being used completely incorrectly.

Centre for Retail Research
Since we returned to economic forecasting in 2003, we have had a successful few years. We correctly forecast the retail downturn in 2005-6, when others were blithely optimistic. We were correct about Christmas 2005 and 2006 (optimistic when others were blithely pessimistic 'the worst Xmas for 20 years' etc). So far we have been correct in portraying the likely path of the UK economy in the current crisis as being neither a major slump nor a few miserable months before resumption of normal trading. However we did not spot the crisis arriving last year. Before it happened, we would have doubted the theoretical possibility of a modern-day recession caused by banks being afraid to lend to one another.

What is the Nature of the Current Economic Crisis?
There has been such an extensive account of the causes of our current problems elsewhere, that we'll keep this short.

Essentially, financial panic that started with American mortgages and affected banks over much of the world has cut liquidity and the money supply, cut the sale of houses, and hit the domestic and commercial property markets. Consumer confidence and spending is cut to ribbons.

The three industries mainly affected are: banking/finance, housebuilding/ construction, and retailing. How important is this? Financial services and retailing together account for around 30% of the UK gross domestic product (GDP) - so pretty important.

This is accentuated by a separate phenomenon - the increase in oil, food, and commodity prices, which produce a shift in assets in favour of producers of oil, farm goods, and raw materials.

Whilst the impacts of the financial crisis and the commodity-price crisis are serious, we feel that much of the comment from media and politicians is actually frightening people. We are talking ourselves into a depression. In the US and the UK (but also France, Germany and Spain) this has a sharply political dimension, with loose talk aimed at harming deeply-unpopular governments. Commentary seems to be directed to showing that actually things are very much worse than they seem to be, which is scarcely settling. It would be just about acceptable if the people now advising us that 'Ye're all doomed' had themselves adopted a frugal lifestyle during the economic upswing.

What Needs to Go Right?
The state of Retailing is a 'leading indicator' that signals when things are turning nasty, but is one of the first to improve when things are starting to go right. Indications are varied, but retailing has been in trouble for a year. By June 2008 UK retail spending had fallen by 0.4% compared to last year and this spending itself was propped up by extensive retail price-cutting and starting sales early. Retailing will not get out of trouble until our economic woes start to ease.

When this occurs will depend on several things going right:

• When oil and commodity prices stop rising or even go into reverse - the Budget based its predictions on oil at $83 a barrel, now it is more than $148 a barrel.
• When it becomes clear that inflationary pressures will not create a wage-price spiral in the UK, pushing the rate of inflation permanently higher. This also requires the current occasional public-sector strikes to fizzle out.
• When bank liquidity improves so that they lend more readily to one another. When banks get in difficulties, they need to be rapidly sold or nationalised so that the financial system does not break.
• When it is clear that other sectors of the economy will not be severely hit by the slowdown. So far everything looks benign with a three-month unemployment rate to May 2008 of 5.2% compared to 5.4% over one year, although according to the CBI one-half of major employers expect to sack workers over the next period.
• When the housing market improves so that buyers are matched with sellers.

Obviously all these things could change tomorrow. But, as shown above, a lot of things need to go right before that occurs. We feel that the single most important one is bank liquidity (see the end of this paper), although many others see ending the rise in oil and commodity prices as being most important.

At present (July 2008), the economy is not in too bad a shape and the Treasury and Bank of England have made it explicit that any public sector or other wage-price spiral will be met with rate increases and monetary tightening. The prices of resources, oil and food are not likely to continue rise at the current rate through 2009, because, as seen in the 1970s, the fall in demand will put a barrier against this.

Statistical problems
We have felt for the last two years that the data published by the ONS (Office of National Statistics) do not report retail sales accurately. We first reported our fears in 2006, but were particularly concerned about the January 2007 results (see Retail Sales graph) which showed sales see-sawing between December 2006 to to March 2007. This is happening again - not the massive rise in the barchart in May 2008 and then the massive fall in June. This, we think, is the result of the ONS being too wedded to the old structure of retailing, insufficient measurement of aggressive discount stores, and weak data on Internet sales.

Increasingly, retailers are reducing prices across the range or concentrated on a small number of items and bringing in many new products for a short period only. This makes it exceptionally difficult to calculate changes in volume, particularly on a monthly basis.

Therefore the best (or least bad) measure of retail output for the next few years is likely to be retail sales value rather than volume measures. Although one will have to take price inflation into account, the problem is that ONS volume data on a current basis is likely to be incorrect.

General Outlook for Retail Sales
As explained in January 2008, we feel that unless there is a sudden deterioration this recession will last two years. However, unlike our January forecast, we feel its impact will be more severe and that there is little chance of a sizeable upturn in the latter part of 2009. We are very optimistic about 2010.

Over the next 12 months, in volume terms - ie allowing for inflation - we expect

Retail sales / Fall by 0.8%-1.4% /
Food & drink / Increase by 0.8%
Household, consumer goods / Fall by 4.7%
DIY/hardware/ / Fall by 6.0%
Entertainment / Fall by 1.9%
Books & stationery / Fall by 1.9%
Other / Fall by 1.0%
Internet sales* / Increase 55%
(* includes retail merchandise only, not tickets or travel)

This relates to major sectors only.

The performance of individual businesses may be very much better or very much worse than the above forecast.

Two Hard Years to Come: Who Benefits and Loses?
Although the financial services sector expects to lose 100,000 jobs, the areas that are least affected by the downturn will be prosperous ones, either attractive in themselves or recently modernised, with a good range of shops, surrounded by middle-class dormitory areas, particularly those with a high proportion of older 45-60 year people (low mortgages, high salary, high net worth).

Internet sales will continue to boom, increasing by a cumulative 55% per year.

Middle-of-the-road stores and franchisees will have a problem - too expensive and uninteresting for the poor and the strugglers, their clientele will become increasingly elderly. More prosperous consumers will also avoid them in favour of a combination of more aggressive discounters and quality middle-class shopping.

Successful business areas will include mothers and babies (at last, a baby boom), food supermarkets, electronic games, recreational wear and cycling. Good quality environmental/ethical retailers should do reasonably well if what they do is related to what people prize, they tell a good story, and they are located in a reasonable shopping area.

This could be the time, when multiple retailers with hundreds of stores decide to close 20% to 30% of their retail branches to concentrate on the Internet and their remaining more successful outlets.

The Crisis: 2008-2010 Retailing's Best of It and Worst of It

The Worst of It / The Best of It
Second- and third-tier shopping centres / London retail
Out-of-town retail parks, particularly remote and/or nondescript ones / Internet retailing
Nondescript second and third rank towns such as Northampton, Coventry, Bradford, Banbury, Huddersfield / Centres of high-quality revamped major cities like Birmingham, Leeds, Glasgow, Cardiff
Landlords and property developers / Food and drink retailers
Middle-of-the-road retailers selling to lower income consumers / Smartish areas of towns with a good range of traffic-builder stores and nice independent stores
Low-income areas, former industrial areas of England and Wales / Market towns with significant middle-class enclaves, e.g. Newark, Chipping Norton, Harrogate, Malton etc
Badly-thought through, costly takeovers / Large aggressive retailers with low cost base that gobble up competitors without overpaying
DIY/hardware, furniture, carpets / Discounters
Electrical retailing through stores / Garden products
Clothing and footwear retailers, particularly middle-of-the-road / Holiday towns with a good reputation
Tired-out City centres / Farmers
Butchers / Electronic games
Premium products/retail formats not meeting valued customer requirements. / Green retailing formats that are more than middle-class twaddle
Newsagents, toys, / Mother and baby stores
Coffee shops / Bicycles, leisure outerwear, pet shops

How Do We Stand Compared to Others? European Retailing Prospects 2009

Britain is not the only country affected by these worldwide problems. Here are our predictions for a range of other European countries in 2009. The classification relates to retailing only.

Most commentators would agree with the five countries in the Poor category, with Portuguese retailers likely to have the easiest time among them.

Most commentators would probably agree with the Weak-ish category, although retailers in The Netherlands may do rather better than that.

Retail Prospects in 18 European Countries 2008-09
Quite Good
(Retail growth 0.2%-1.2%) / Weak-ish
(Retail fall ½% - 1½%) / Poor
(retail fall 2½%+)
Poland / UK / Italy
Finland / Denmark / Greece
Switzerland / France / Spain
Sweden / Netherlands / Ireland
Germany / Belgium / Portugal
CzechRepublic
Russia
Norway

The first category is more problematic. First of all for retailers in the Quite Good category these growth prospects represent for them a significant cutback (apart from Poland and the Czech Republic). We expect the growth in GDP to weaken, but it will still be better than the other countries in this table. If consumers respond to the fall in the upward rate of growth by saving more, then retail outcomes will be worse than predicted.

The Virtues of A Little Bit of Cheating
It was Aristotle, reflecting on the difficulty of defining 'virtue', who declared 'Cowardice is a virtue: the brave man knows when to run away.'

There is a long economic tradition in the UK of forgetting the plot and making some synthetic policy mechanism into a religion. The Gold Standard, Fixed Exchange Rates, Price and Incomes Policy, the 'Balanced Budget', and Monetary Policy in the 1980s (so-called Monetarism, see next section) are a few examples.

For the last ten years, Gordon Brown has advocated key mechanisms for controlling borrowing and public spending generally known as Prudence (over the economic cycle only borrow to fund capital expenditure, public borrowing should not exceed 40% of GDP, etc). Each one of these policies has (or had) a fundamental economic truth at its core, but none of them were effective in promoting stability over the whole period of an economic cycle. Moreover, definition is EVERYTHING. Those of us who were keen to see monetary control as a valuable part of an attractive economic policy in the 1970s and 1980s were surprised to find that whatever definition of Money you used, M0, DCE, M1, M2, M3, M4, M5, the relationship broke down as soon as you used the measure as a control mechanism (the so-called Goodhart's Law). For those who found Money Supply or Monetarism a religion, this was deeply upsetting. For those of us who saw economic management, reduced unemployment and faster growth, as the key principles, with tight money as a way of delivering those principles rather than an aspect of moral virtue, this simply demonstrated how hard it was to control a modern economy.

Now is the time, therefore, without lamentation to engage in a little bit of cheating, to relax the rules controlling increases in public borrowing and to be less strict in our adherence to Prudence, because:

• The economic world has changed rapidly: what was good two years ago may not be so relevant today;
• Public-private partnerships and the state ownership of one or more banks to prevent a financial collapse both undermine the normal definitions of 'public' such that it is no longer clear how the Prudence principles can be applied.

This is also the opportunity to ensure there is sufficient liquidity in the financial system by relaxing the rules on which the Bank makes liquid assets available to banks. The danger is not the collapse of Western capitalism, but that inadequate and unwilling responses to the current structural problems in finance will prolong the recession beyond 2009.

Monetarism for The Noughties
Friedman's ideas (remember him?) were grounded in the historical research he carried out with Rose into the US financial and economic mismanagement that gave rise to the slump of the 1930s. He saw the slump as a monetary phenomenon, not caused by the failure of Keynesian-style demand management. Although Monetarists are best known for demanding the most stringent control on Government spending (and probably not being very nice people), their view is that changes in the money supply (or Money) cause similar changes in economic behaviour.

We stand now in the same position as economic managers and bankers in the early 1930s. The money supply is falling rapidly in the US, the UK and the Eurozone (see charts). You do not have to be a card-carrying Monetarist to conclude that if money supply is falling then economic activity will fall also.

The problem we face is one of liquidity, not interest rates. The level of the Bank Rate (the old term is back) is fine, although liquidity shortage means that actual interest rates have risen and the terms of loans are much more stringent.

People who call for Bank Rate reductions fail to understand what is happening in financial markets. Liquidity is the problem. The reason banks now don't lend to one another is a chronic shortage of financial assets, not the price of money. The Bank of England special funding scheme (or 'program' for American readers) to add liquidity to the market needs to be trebled in size and made much easier to use. The scheme was introduced hurriedly after the Bear Stearns (US) collapse, although a comparable programme had been running in the Eurozone since December 2007.

It is no doubt fun for the Bank of England managers to apply the maximum pain to the Clearing Banks and say 'We told you so!' (did they?), but reforming the behaviour of banks should be left until the economic climate improves. We can sort out the banking system later. Meanwhile there may be one or two more UK banks that need to be taken into care and it is best if this is done cruelly and with great speed rather than be the cause of universal lamentation.

'Hard pounding, Gentlemen' as the Duke of Wellington announced to his officers during the Battle of Waterloo as cannon fire was blowing off their arms and legs.

For 2008-2010 this could be the watchword of every retailer in the land.