There are many reasons to be concerned over the outlook for the UK consumer; historically high levels of debt, a stagnant housing market, rising unemployment, and the prospect of tighter fiscal policy in 2006. But the market already knows this and has moved back to pricing in a good chance of another rate cut in the first quarter of 2006.
General retailers have been underperforming, declining year to date, in an upwardly trending market, and the media has again been filled with the Cassandras, bemoaning the decline of the UK consumer, and imminent recession. Such talk has been fuelled by the retailers, overlaying the ongoing consumer slowdown with intense competitive pressures on the high street and continued pricing pressure. Column inches have been filled by quotes from self interested industry bodies, such as the British Retail Consortium, lobbying for aggressive rate cuts.
To be fair, it is difficult to be bullish (and easy to be bearish) on the UK consumer, given the well-known and oft-observed issues such as overleverage and sensitivity to housing. That said, when everyone is bearish, and when the global economy appears to be enjoying an upturn (albeit one that is likely to be short lived) one should consider the alternate scenarios and the fact that events in the UK have unfolded more favourably (or alternately, not quite as badly) than the bears would have us believe.
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Clearly, the Chancellor has been fortunate enough to change his view on the time when this business cycle began - the upshot of which conveniently enables him to defer (or potentially avoid) fiscal tightening through spending cuts or tax rises. This removes a potential, and previously expected, drag on UK growth in 2006.
Changes in market expectations have also avoided some further pain for the UK consumer this year. Essentially, bearish expectations on the consumer have helped to stabilise the outturn. Recall the environment in 2003. Equity markets were on their knees, with the FTSE below 3300 (more than 35% below current levels), bond yields were collapsing, and the bears were in their element.
That year, £100bn of fixed rate mortgages were taken out, at record low rates as low as 3.5%. Most people (around 80%) who take fixed rate mortgages take them for two years, meaning that 2005 saw some nervous homeowners eyeing the latest deals and calculating the extra payments they would be due. The recent turn in interest rate expectations has, to some extent, eased the pain of the refinancing cycle.
The Cassandras are wailing but, believe it or not, they are still waiting for the crunch to arrive and, given an improving external backdrop, depressed expectations, and gradual near term improvement in underlying consumer data flow, they will likely be frustrated once again.
By Paul Niven, Head of Strategy at F&C Asset Management
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