Pound Sterling Spikes Higher after UK Retail Sales Growth Hits Post-Brexit High

-GBP rises after retail sales surge, aided by weather and weddings. 

-May retail sales rise 1.3% on month and 3.9% on annualised basis.

-Analysts see data supporting expectations of August BoE rate hike.

© Alice Photo, Adobe Stock

The Pound spiked higher Thursday as trader responded to Office for National Statistics data showing retail sales rising apace for a second consecutive month in May, suggesting the economy may finally be recovering from its first-quarter slump and helping to support expectations of a Bank of England interest rate rise in August.

UK retail sales rose by 1.3% during the recent month which, although down from an upwardly-revised 1.8% in April, is substantially ahead of market expectations for growth of just 0.5%. This saw the annual rate of retail sales growth rise to 3.9% in May, up from 1.4% previously, which is far ahead of the consensus for an annualised increase of just 2.4%.

"May’s retail sales figures have added to the evidence that consumer spending growth has picked up some pace following the softness at the start of the year," says Ruth Gregory, a UK economist at Capital Economics. "Even if sales were to post a big drop of 1% or so in June, they should still rise by a quarterly 1.8% in Q2, the largest quarterly gain since Q1 2016 and a vast improvement on Q1’s 0.3% quarterly fall."

All main sectors of retailing saw an increase in sales, which the ONS says were aided by warmer weather and the Royal wedding, during May. This draws a definitive line under the contraction seen in March, when consumer spending had been hampered by a period of poor weather at the beginning of the month. 

"Since retail sales account for around a fifth of GDP this could add as much as 0.4pp to growth in Q2 relative to Q1 – although the boost is unlikely to be quite this large given the evidence of weak spending off the high street," Gregory adds.

Gregory also says that, with the rate of inflation now below the average rate of weekly pay growth in the UK, a return to "real" household income growth can support a further pick up in spending later in the year. This would help to support a recovery in the rate of UK GDP growth, which fell to 0.1% in the first-quarter after a 0.4% rise at the end of 2017.

The Pound was quoted 0.43% higher at 1.3440 against the Dollar while the Pound-to-Euro rate was 0.24% higher at 1.1365. Sterling was also higher against all other developed world currencies following the release.

“For the third time in as many days the currency markets are responding to new data about the state of the UK economy as investors look for signs that would indicate an interest rate rise in August," says Lee McDarby, managing director of corporate FX and international payments at Moneycorp. "Earlier in the week we saw the Pound fall in response to poor manufacturing and wage data, but today we can expect Sterling to bounce back."

Markets care about the retail data because it is a leading indicator of economic growth and because of the influence that rising or falling consumption can have on inflation. It is inflation that central banks are attempting to contain when they raise interest rates, and rates themselves are the raison d'être for most moves in currency exchange rates.

Capital Economics, as well as the broader market, have taken an upbeat view of Thursday's retail statistics but others are not quite as impressed. 

"The jump in retail sales in May has all the hallmarks of a weather-related blip, rather than a sustainable pick-up in spending. Overall growth was boosted by sharp increases in sales of clothing, sporting goods and garden items, up 1.7%, 3.3% and 6.2% month-to-month, respectively," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

Like Gregory, Tombs says that UK retail sales are likely to make a greatly improved contribution to UK economic growth in the second-quarter, although he also warns that this is unlikely enough to support a complete recovery in GDP growth. 

"Households also often fund sharp increases in retail sales by cutting back on services spending. In addition, the very poor start to the quarter in the industrial and construction sectors suggests that GDP will rise by a mere 0.2% in Q2, undershooting the MPC’s 0.4% forecast," Tombs writes, in a recent note. 

Thursday's data comes after a two month period of losses that have seen Sterling convert a 4% gain over the Dollar into a 1% 2018 loss while the Pound-to-Euro rate has fallen so that a 2.5% gain has become a mere 1% profit for the year to date. The 2018 decline in inflation has been at the heart of this depreciation.

Sterling had performed strongly between February and April as the consumer price index remained close to 3% and the Bank of England warned it would raise interest rates faster and further than markets gave it credit for if the inflation picture evolved in line with its forecasts.

The BoE predicted back then that inflation would remain above the 2% target until at least the end of the first quarter 2021. However, the consumer price index fell from 3% in February to 2.4% in April and held at this reduced level for May. Many economists also expect it to fall further during the quarters ahead. 

This and a first-quarter economic slowdown led the BoE to abandon the idea of a May interest rate rise, which has further weighed on the Pound, leaving markets looking to the August meeting for the next possible rate hike.

The overnight index swap implied interest rate for August 02 was just 0.55% Thursday, suggesting around a 20% probability the BoE raises rates at that meeting. Thursday morning's retail sales data may have just lifted that implied probability by a fraction. 

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