Is consumer resilience under threat as rates keep climbing?

British retail giant Next has long been seen as a barometer of the health of the high street (both bricks and mortar and virtual) so when it puts out an unscheduled trading update, markets pay attention.

It noted that the warm weather had seen shoppers flocking to its stores to update wardrobes, a phenomenon that rival H&M also enjoyed as summer finally hit the continent in earnest at the start of June.

But what really captured the attention of analysts was the assertion from Next that those big pay rises being dished out by employers had led to “a significant uplift of real household income” which was mitigating the worst impact of inflationary pressures.

With Next perceived by investors as the master of understatement, its shares shot to the top of the FTSE 100 immediately after its update, dragging a host of other retailers in its wake.

The key is consumer confidence, and that’s something that has been growing in recent months despite continued headlines about the ‘cost of living crisis’, stubbornly high inflation and a meltdown in mortgage markets.

What really captured the attention of analysts was the assertion from Next that those big pay rises being dished out by employers had led to “a significant uplift of real household income”

UK consumer confidence over the past five years

Source: Refinitiv

Wages might not have kept up with inflation, but real pay has grown at the fastest rate in 20 years (if you strip out the pandemic) and the tight labour market has prevented businesses from shedding staff, even if their sums don’t quite add up.

The cost of food shopping falls as price wars intensify

Inflation is proving sticky, even if the food sector, which has been a main cause for concern amongst households in recent months, is cooling.

But grocers are still under pressure to do more, after allegations of profiteering which they strenuously deny, and a new bout of price wars has commenced which is likely to put more money back in shoppers’ pockets.

Tesco, Sainsbury and Marks & Spencer have all slashed the cost of “everyday essentials” – something which hasn’t been appreciated by shareholders but is essential if they’re to prevent their customer from voting with their feet.

Because the cure for bringing down inflation has created another economic ailment.

UK 2-year gilt yield

Source: Refinitiv

The cost of government borrowing over two years has topped 5% for the first time since 2008 as markets priced in further moves by the Bank of England.

It’s piled even more pressure on lenders who pulled products or raised the rates on the average 2-year fixed mortgage above 6%.

For homeowners facing re-mortgaging the reality is pretty stark.

Mortgage mayhem

The Resolution Foundation has warned that just under half of the 7.5 million mortgage holders in the UK haven’t yet faced an increase in their payments, but 3.3 million households are expected to face that cliff edge between now and 2026 – with the expectation that rates won’t fall below 4.5% until the end of 2027.

Middle earners with savings cushions were broadly insulated from the worst of the energy crisis but those saving cushions have been whittled away

It estimates the average jump in annual repayments will come in at a whopping £2,900 – an amount that can’t help but impact the amount of disposable income those consumers have to spend in shops like Next.

For its part, Next has always been a master at under-promising and over-delivering which is why its full guidance was only moderately up-rated as the company anticipates that the benefits of pay rises will be eroded by cost pressures.

But retail won’t be the only sector warily watching mortgage movements.

Middle earners with savings cushions were broadly insulated from the worst of the energy crisis. But those saving cushions have been whittled away and there are numerous accounts of living standards having to be pared to the bone as those ultra-low rates of the past are resigned to the history books.

Will these consumers still be able to take that long weekend at places like Centre Parcs, which has done such a roaring trade post-pandemic that its imminent sale has attracted a whole lot of interest from foreign investors rumoured to include Pinewood Studios’ owner Aermont?

And what of the housing market? So far house prices have shown little sign of distress with Rightmove reporting that the average asking price dropped in June for the first time this year, but only by £82.

But it’s predicting a fall in asking prices by 2% by the end of year and housebuilders are already re-drawing hastily re-drawn plans.

Yes, the consumer has been resilient, but the very thing that has shored up that resilience, those elevated wage increases, have sparked concern about a wage price spiral which UK central bankers are desperate to prevent.

Earlier comments by some MPC members might have been “clumsy” at best but the underlying sentiment was sound and as a new cost-of-living crisis emerges from the old there will be plenty more calls for government intervention.

With an election in the offing quick fixes might be seen as vote winners and creating a recession a sure-fire vote loser, but inflation is a funny beast and one economies right around the world are still struggling to tame.

Past performance is not a guide to future performance and some investments need to be held for the long term.