Pound Rises after UK Retail Sales Stage Robust Recovery from June Slide

-UK retail sales catch market offguard with strong July increase.

-Data showcases consumer resilience but has no implications for BoE. 

-Offers limited support to GBP, which is fixated on Brexit, global factors. 

© IRStone, Adobe Stock

The Pound advanced against rivals Thursday as traders responded to official data showing spending on the high street rising faster than was expected during July, drawing a line under the surprise slump seen back in June.

UK retail sales rose by 0.4% during July, up from the -0.5% contraction seen back in June and far ahead of the analyst consensus for a lesser 0.2% increase. This saw the annual pace of sales growth rise from 2.9% to 3.5% in volume terms.

Sales volume growth after motor fuels are excluded from the data were even stronger, rising by 1.2% in July, when they had fallen by -0.7% in June. This pushed the annualised pace of growth up to 5%, from 4.4% in June.

"Retail sales posted a robust increase in July, suggesting that some recovery in consumer spending is in the pipeline," says Andrew Wishart, a UK economist at Capital Economics. "Of course, retail sales only account for about a third of total household spending, so the strength of spending on the high street could be offset by households reducing their outlay elsewhere."

Much of the growth was driven by an increase in spending at food stores and online retailers, while non-food stores saw a continued decline in footfall during the recent month, which the Office for National Statistics says is the result of consumers enjoying the warmer weather and football World Cup in the outdoors.

The increase in total sales was driven primarily by a huge 4.9% month-to-month increase in the non-store sales. We doubt it is a coincidence that the jump coincided with Amazon’s Prime Day discount period, which ran from July 16 to 17. The World Cup, which encouraged people to stay at home, also might have spurred a rotation in spending from stores to online," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics. 

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.

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"With the sun shining, UK retailers had another decent month in July," says James Smith, a developed markets economist at ING Group. "But now that the wind and rain are back with us, we suspect the cracks in the high street are likely to become more visible once again."

The Pound was quoted 0.19% higher at 1.2717 against the Dollar following the release but is still down 5.8% for 2018, while the Pound-to-Euro rate was down 0.23% at 1.1169 and has dropped 0.6% this year.

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Pound Sterling Vulnerable to Fresh Losses

"GBP/USD has been unravelling in recent weeks – although most of this has been due to extrinsic factors, with GBP assets hit by a double dose of risk premia: (1) a UK-specific risk premium capturing the obvious heightened no-deal Brexit risks and (2) a global risk premium stemming from geopolitical uncertainties and Emerging Market turmoil," says Viraj Patel, an FX strategist at ING Group. "Both have left GBP/USD trading at a significant discount from short-term fundamentals."

The Pound has already reached Patel's third-quarter target of 1.27 against the Dollar, although he warned Thursday that headlines relating to Brexit and other global risk factors could easily drive it below this level over coming weeks. 

"Equally, we are uncomfortable over chasing GBP much lower now – especially in the absence of any tangible signs that we’re heading towards a no-deal Brexit. The prospect of a last-minute deal (as history has proven) on the Irish backstop means that risk-reward no longer favours pricing in no-deal Brexit risks – with scope for a sharp GBP rebound in this scenario outweighing any momentum driven moves lower," Patel writes, in a note to clients.

Thursday's retail number comes hard on the heels of inflation data for July, which showed the consumer price index rising for the first time since November 2017, albeit at a pace that proved insufficient for it to have any implications for Bank of England monetary policy.

The Bank of England raised its interest rate to 0.75% in August, citing its own inflation forecasts that put the consumer price index above its 2% target until the end of the BoE forecast horizon. 

However, UK inflation has fallen faster than was expected this year and momentum in the economy has been lacklustre, suggesting that organic inflation pressures remain underwhelming.

UK GDP grew by just 0.4% in the second quarter while consensus suggests it will rise by only 1.3% for 2018 as a whole. The UK economy grew by 1.8% in 2017, down from 1.9% in 2016 and 2.2% in 2015.

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BoE on Hold, Brexit in Focus

Many economists now forecast inflation will fall back to the BoE's 2% target by early 2019 at the latest, which means Bank offficials may struggle to justify raising interest rates again in the near future.  

"The medium term picture looks quite benign now for inflation in the UK and with the pass-through from GBP depreciation now complete, the outlook for inflation will be more determined by domestic demand conditions. While the UK labour market is resilient, the pass-through to inflation from wage growth looks unthreatening for now," says Derek Halpenny, European head of global markets research at MUFG.

August's move by the BoE marked the second rate rise inside of the last 12 months, although markets have since been reluctant to bet that another will be delivered any time soon, due largely to uncertainty over the trajectory of the Brexit negotiations and the impact that an eventual EU exit might have on the economy.

Thursday's price action puts Sterling near to an 18-month low against the Dollar, despite a second interest rate rise from the Bank of England delivered in early August, as markets are increasingly concerned about the prospect of the UK departing the EU and defaulting to trading with it on World Trade Organization terms.

"That would bring a short-sharp economic hit, and probably BOE easing. It goes without saying that it is bad for sterling. Giles Fraser, writing in the Telegraphyesterday, argued that the UK survived the first Brexit - the Reformation - and can do it again. That's true, but Henry 8th's debasement of the coinage saw sterling fell by about 70% in value," says Kit Juckes, chief FX strategist at Societe Generale.

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