Retail Sales Beat Helps Pound to 2-Year Best Against Euro

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Pound Sterling rallies after UK retail sales jump.

The Pound to Euro exchange rate (GBP/EUR) rose to its highest level in more than two years after UK retail sales beat expectations, rising 0.3% month-on-month in September.

This was ahead of expectations for a reading of -0.3%, which is why the Pound rose against all its major G10 peers.

Retail sales rose 3.9% year-on-year in September said the ONS, which was more than the 3.2% increase the market expected. Core retail sales rose 4%, which was more than the 3.2% expected.

For euro buyers, this is the best exchange rate in more than two years, with the best providers now offering rates above 1.20.

The rise in retail sales was broad based with sales increasing in five of the seven sub-sectors.

These are strong data that suggest the UK consumer is increasing in confidence, thanks to pay increasing faster than inflation, resulting in growing real incomes.

"While households may be concerned about possible tax rises in the Budget on 30th October, those fears are not feeding through to their spending decisions yet," says Alex Kerr, UK Economist at Capital Economics.

The consumer has shown a propensity to save over recent years and there is ample room for spending to increase in the coming months if confidence improves.

In sum, there is ample demand in the UK economy, which can drive up the cost of goods and services.

For the Bank of England, it is an inflationary development and would suggest caution needs to be exercised when considering the pace of future rate cuts to come.

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The Bank will cut interest rates again in November, but a question mark once again hangs over the December meeting.

Markets raised the odds of a December rate cut when a midweek release showed a resounding undershoot in inflation right across the board.

These retail sales show that falling prices are stimulatory in isolation, and the Bank should be cautious about whether there is a need to slash rates to juice the economy.

"The consumer sector is very important within the economy and even though this is just one month’s data, it suggests the economy is more robust than was thought," says Neil Birrell, Chief Investment Officer at Premier Miton Investors.

For the Pound, the prospect of a steady approach to cutting rates is a supportive development. On Thursday the European Central Bank (ECB) cut rates again as it signalled concerns the economy was stalling.

The divergence in Eurozone and UK monetary policy is proving a strong driver of GBP/EUR upside, that could have further to run if the exchange rate can hold gains above 1.20.

"Looking ahead, as real incomes continue to grow, we expect retail sales to contribute to an acceleration in overall consumer spending growth," says Kerr at Capital Economics.

"That said, if taxes rise in the Budget by more than we expect, real household incomes and consumer spending growth may be a little softer. But any adverse impact on consumer spending will likely be offset by higher government spending," he adds.