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Retail Sales Slump Confirms Poor Hand-off into Final Quarter for U.K. Economy

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- U.K. retail sales surprise on downside with October decline.

- Confirms poor handover into final quarter for the economy. 

- Both retail sector and economy eye Brexit clash in parliament.

U.K. retail sales surprised on the downside Thursday after official data revealed a decline in spending on the high street during the month of October, marking a poor start to the final quarter for the economy.

Sales volumes fell by -0.5% in October, after a donwardly-revised -0.4% decline in September, when consensus had been for a 0.2%. 

This pushed the annual growth rate down from 3.3% to 2.2% when markets had been looking for it to settle around 3%.

A sharp fall in sales at household goods stores drove the overall decline, although October followed a strong two month period for that segment of the market, according to the Office for National Statistics.

"October’s fall in retail sales is the first real sign that consumers are tightening their purse strings due to uncertainty about Brexit," says Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics. "The weather can't be blamed for the poor performance; average temperatures in both September and October were very close to their long-run averages."

Tombs also says consumers may have deferred some October spending until "Black Friday" in November to a greater extent than in previous years, but flags that this would be unusual and economists will soon be able to tell.

Retail sales are around one third of overall household spending, and the latter itself accounts for a significant portion of GDP, so spending data often provides important insight into the pace of U.K. economic growth.

U.K. growth slowed from 0.4% at the end of 2017 to just 0.1% in the first quarter. It then rebounded, with GDP rising 0.4% in the second quarter and 0.6% in the third, but consensus is that output will grow only a paltry 1.3% for 2018.

"With inflation continuing to fall back – note that the retail sales deflator slipped from 1.8% in September to 1.6% – and pay growth on the up, there should be scope for consumer spending growth to gather some momentum further ahead," says Thomas Pugh, an economist at Capital Economics.  

Financial markets care about the data because of the influence rising or falling consumption can have on inflation. It's inflation that central banks are attempting to contain when they raise interest rates.

"If a Brexit deal is struck and the UK enters into a transition period or indeed, if there is no Brexit at all, then we think that annual consumer spending growth will pick up from its current rate of 1.6%, to 2% in 2020," Pugh adds.

Pugh also says that if there were a "no deal Brexit" then retail sales could fall up to 3% in 2019, depending on how messy the eventual exit is.

"The initial signals from October data showed a poor start to Q4, as business sentiment surveys, consumer surveys, and now retail sales have all shown deterioration," says Fabrice Montagne, an economist at Barclays.

Inflation rose at an annualised pace of 2.4% in October, unchanged from the previous month, although consensus had been for a 2.5% increase.

The Bank of England (BoE) raised its interest rate to 0.75% in August, citing its own inflation forecasts that suggest the consumer price index will remain consistently above the 2% target over coming years. 

BoE officials have also been saying that rising household pay will stoke even further inflation pressures during the quarters ahead.

ONS data released this week showed the average wage packet grew at its fastest pace since 2008 during the three months to the end of September. Wages rose 3% on an annualised basis, up from 2.7% in the prior period.

"The ongoing ambiguity suggests that economic data will largely be overshadowed. However, it should not be totally ignored, as the BoE’s economic projections suggest the risk of a faster pace of tightening next year if a Brexit deal is achieved," says Robin Wilkin, a cross asset strategist at Lloyds Bank

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