- A rate rise is expected, but its timing is critical
- A 0.5% increase in the Bank Rate would increase the average consumer’s annual mortgage payment by £317
A rise in interest rates could affect consumer spending and the retail sector if introduced within the next six months, warns the KPMG/Ipsos Retail Think Tank.
The Retail Think Tank believes that public confidence in the economy needs to rise significantly before interest rates are increased, or concerned consumers could reduce their spending. This warning follows the latest retail sales data published by the BRC and KPMG, which revealed that consumers have already begun to cut back on big ticket items like furniture, in anticipation of an interest rate rise.
Neil Saunders, Managing Director of Conlumino, said: “The economy is getting stronger, but sentiment is lagging behind. People are worried about the timing and ferocity of a potential rise in interest rates. We are already seeing sales of some items decline as people formulate a contingency plan in case rates do go up this year.”
Nick Bubb, Retail Consultant to Zeus Capital, said: “For some consumers, who have relied on there not being an increase in rates before the Election next year, the first rise will come as a shock. And a rise in November will not be obviously helpful to uninhibited consumer spending at Xmas.”
Unless wage growth picks up significantly and consumer confidence builds, the Retail Think Tank believes that a rise in interest rates this year could impact the retail recovery.
“The foundations of confidence just aren’t there yet across many parts of the country,” said David McCorquodale, Head of Retail at KPMG. “If the rate rise comes at a time when the average UK consumer is not ready for it, then it could be damaging to the retail sector. But if rates rise just as the economy begins to purr then it won’t hurt retailers as much, because other factors such as wage inflation will offset the rise both financially and emotionally.”
The Retail Think Tank believes the way in which the increase in rates is communicated will play a fundamental role in building or destroying consumer confidence. The long term benefits of the rise need to be sold to consumers, so it does not appear merely punitive and consumers also need to be persuaded that any rise is likely to be a small manageable increase, rather than a sudden hike.
James Knightley, Senior UK Economist at ING, said: “By implementing small rises to dampen inflation the Bank of England hopes to slowly readjust the economy and avoid storing up problems in the long run. This is a positive strategy for consumers, but the message is getting lost in translation.
“Consumers shouldn’t be fearful of a sudden dramatic rise in interest rates: it’s unlikely to happen. Wage growth is also on their side. If pay packets rise by 3 to 4 percent then this will make a moderate rise in interest rates affordable for the majority of households.”
“In fact the psychological impact of a rate rise is likely to be more powerful than reality itself,” added Tim Denison, Director of Retail Intelligence at Ipsos Retail Performance.
“There is also the misconception that an interest rate rise will hit consumers immediately, and this is creating significant anxiety,” said Richard Lowe, Head of Retail and Wholesale at Barclays. “However, many people are on fixed rate mortgages for a set term, so if rates rise they will have time to prepare.”
The Bank of England has also introduced other measures to tackle the UK’s purported property boom, which many believe to be mainly South East and London centric, thus reducing the likelihood that it will just use an interest rates rise to control prices.
Mark Teale, Head of Retail Research at CBRE, said: “The decision of the Bank’s Financial Policy Committee to ration purportedly ‘risky’ mortgages, rather than use a national interest rate hike as a sledge hammer to stem house price inflation in inner London, has headed-off the immediate risk of a knock-on nationwide consumer spending downturn. The bank has other weapons in its arsenal to control house prices, such as the new affordability tests, which should control mortgage indebtedness.”
The rise also won’t affect all of the population. Martin Hayward, Founder of Hayward Strategy and Futures, said: “The almost obsessive commentary about house prices and mortgage rates does tend to obscure the reality that in the UK there are more net savers than borrowers. Recent data suggests that only about a third of the population have property debt yet their voices have consistently drowned out those who don’t.”
Rise in rates will benefit the discounters...
However, a rise in rates will mean that some consumers will see their discretionary income fall, as higher rates push up debt servicing costs, leaving them with less to spend.
James Knightley of ING said: “For some households, higher interest rates will push up debt servicing costs, leaving less income to spend on goods and services. For others it will make saving look a more attractive option.
“The most recent set of numbers published by the Office for National Statistics show that the median size of an outstanding mortgage is £84,000. Assuming that mortgage was originally £100,000 then every 0.5% increase in Bank Rate would increase the annual mortgage payment by £317 – equivalent to 1.6% of the after tax income of a typical British worker. With many households already being squeezed by the fact pay has not kept pace with the cost of living for over five years, those that are exposed will see their spending power dented.”
Tim Denison of Ipsos added: “Consumers will be affected unequally and in different ways. There is a risk that the nation will become more polarised and economically divided. Those most affected will be households with existing debts, where even a modest rate rise would hurt their spending power and trigger rent or mortgage arrears. Those least equipped to deal with the effects of a rise will be the generation of home-makers who have never experienced a higher cost of borrowing. The ageing population, though, will help counter reduced demand from the disadvantaged. New pensioners will find themselves especially welcome as favoured customers, following annuity rate rises.”
Some retailers will benefit from a rise in interest rates. The Retail Think Tank believes that the rise will cement the shift to value and discount retailers, especially in the grocery sector where price often determines where consumers decide to spend.
Richard Lowe of Barclays said: “Value retailers will benefit from a rise in rates, as people will inevitably look at their expenditure more carefully, especially those younger consumers who have mortgages and are feeling the pinch. Aldi and Lidl’s store roll out programme will also extend their geographical reach and will mean that more people are able to shop with them.
“In general, retailers might want to look more closely at their value for money proposition and promotional activity to ensure single digit growth this year and beyond.”
...and is unlikely to trigger a wave of insolvencies
The Retail Think Tank does not believe that the rise in interest rates will cause a raft of retail failures. Most retailers have paid down debt over the last five years and lending levels have fallen to more reasonable levels.
David McCorquodale of KPMG said: “Many retailers pre-recession had high levels of debt, partly to support private equity funding structures. Most have managed their debts down to serviceable levels but an increase in the borrowing costs for those retailers will put additional strain on their operating models – the same can be said for their suppliers. I do not predict a deluge of administrations but, perversely, growth can have its own strains, especially around working capital and retailers will wish to ensure that they and their suppliers are able to navigate their way to recovery. Many retailers are exploring supply chain finance to support their suppliers through this change. An increase in interest rates will be felt at this interface.”
The low interest rate policy has inflated the amount of discretionary income consumers had at a time when real disposable income growth has largely been negative. This provided a shot in the arm in terms of spending, but as the economy grows this unusual period must come to an end.
However, the Retail Think Tank believes that the right conditions must be in place before rates go up, to ensure the impact of the rise won’t do serious damage in the long term. Any move this year, when consumer confidence is still precarious, could potentially damage consumer spending and hurt the retail sector.
Mark Teale of CBRE concluded: “If the interest rates increases occur, as seems likely, before sustained economic growth has fed through into significant wage inflation, consumer spending growth can only remain sluggish.”
Note to Editors:
First mentions of the Retail Think Tank should be as follows: the KPMG/Ipsos Retail Think Tank. The abbreviations Retail Think Tank and RTT are acceptable thereafter.
The RTT was founded by KPMG and Ipsos Retail Performance (formerly Synovate) in February 2006. It now meets quarterly to provide authoritative ‘thought leadership’ on matters affecting the retail industry. All outputs are consensual and arrived at by simple majority vote and moderated discussion. Quotes are individually credited. The Retail Think Tank has been created because it is widely accepted that there are so many mixed messages from different data sources that it is difficult to establish with any certainty the true health and status of the sector.
The aim of the RTT is to provide the authoritative, credible and most trusted window on what is really happening in retail and to develop thought leadership on the key areas influencing the future of retailing in the UK. Its executive members have been rigorously selected from non-aligned disciplines to highlight issues, propose solutions, learn from the past, signpost the road ahead and put retail into its rightful context within the British social/economic matrix.
The RTT panellists rely on their depth of personal experience, sector knowledge and review an exhaustive bank of industry and government datasets.
Nick Bubb, Consultant to Zeus Capital
Dr. Tim Denison, Ipsos Retail Performance
Martin Hayward, Hayward Strategy and Futures
James Knightley, ING
Richard Lowe, Barclays Retail & Wholesale Sectors
David McCorquodale, KPMG
Neil Saunders, Conlumino
Mark Teale, CBRE
The intellectual property within the RTT is jointly owned by KPMG (www.kpmg.co.uk) and Ipsos Retail Performance.
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