News

Despite the squeeze on purchasing power, the consumer will cope

News

Dennis Turner

10 January 2011

Investment/finance

It was an impressive turnaround after the 4.9% fall in GDP in 2009, the UK’s worst calendar year since the 1930s. Yet going into 2011, uncertainty is widespread and confidence remains low.

Much of the recovery goes back to the initiatives taken by the previous government to tackle the recession. Lower interest rates, looser fiscal policy, a weaker pound and quantitative easing all helped to get the economy moving.

But each stimulus comes at a cost, in terms of a heightened inflation risk or a build up of debt, and will have to be reversed. This process of tightening policy falls to the new government, and is now under way, with fiscal policy to the fore.

The debate now is less about whether the steps are necessary but whether the economy is robust enough to cope with the withdrawal of a key prop to spending and employment.

Adjusting the fiscal stance puts the chancellor in the spotlight and in October, Mr Osborne set out his intentions to reduce the deficit by £120bn over the next five years. Most attention has focused on the 80% due to come from spending cuts, but the 20% from tax increases will start to bite sooner, with VAT already up to 20% and NIC rising in April.

The consumer sector, which accounts for 62% of all spending and which was the primary driver of growth for a decade or more before the recession, is facing a further squeeze.

In some respects, this is the policymakers’ intention, to wean the UK off its dependence on domestic spending and grow the contribution from exports. But this “rebalancing” is an argument for modest household spending, not a retreat.

Certainly, personal consumption has been reined in, provoked not just by higher taxes, but rising unemployment, consumer price inflation running ahead of earnings growth and the huge debt overhang. Now, in 2011, with job insecurity intensified after the spending cuts, the continuing debt issue and inflation likely to go up before it goes down, households will see the tax burden increase.

Yet for all the assaults on their real purchasing power, consumers have been very resilient. There was a 3.3% fall in consumer spending in 2009, but in the 12 months to September 2010, a modest 2% bounce back. Although the VAT rise threatens to abort this recovery, several factors suggest the consumer will cope.

First of all, continued low interest rates will keep debts manageable, consumer price inflation should ease as the year progresses and the UK’s VAT is relatively narrow, affecting less than two-thirds of consumer spending.

And retailers can also help. Just as many did not pass on Alistair Darling’s VAT cut two years ago, so those concerned to maintain competitiveness and volumes may choose to absorb some or all of the VAT increase themselves rather than add it to price.

Damaging as the tax increase might seem at this point in the recovery, the combined resourcefulness of consumers and retailers may offset the worst effects.

For the first time in a while, the economy ended a year on a positive note. Growth in Q3 2010, of 0.7%, was the fourth quarter of positive growth after 18 months of recession, pushing up the annual increase in output to a healthy 2.7%, writes Dennis Turner, chief economist at HSBC. It was an impressive turnaround after the 4.9% fall in GDP in 2009, the UK’s worst calendar year since the 1930s. Yet going into 2011, uncertainty is widespread and confidence remains low. Much of the recovery goes back to the initiatives taken by the previous government to tackle the recession. Lower interest rates, looser fiscal policy, a weaker pound and quantitative easing all helped to get the economy moving. But each stimulus comes at a cost, in terms of a heightened inflation risk or a build up of debt, and will have to be reversed. This process of tightening policy falls to the new government, and is now under way, with fiscal policy to the fore. The debate now is less about whether the steps are necessary but whether the economy is robust enough to cope with the withdrawal of a key prop to spending and employment. Adjusting the fiscal stance puts the chancellor in the spotlight and in October, Mr Osborne set out his intentions to reduce the deficit by £120bn over the next five years. Most attention has focused on the 80% due to come from spending cuts, but the 20% from tax increases will start to bite sooner, with VAT already up to 20% and NIC rising in April. The consumer sector, which accounts for 62% of all spending and which was the primary driver of growth for a decade or more before the recession, is facing a further squeeze. In some respects, this is the policymakers’ intention, to wean the UK off its dependence on domestic spending and grow the contribution from exports. But this “rebalancing” is an argument for modest household spending, not a retreat. Certainly, personal consumption has been reined in, provoked not just by higher taxes, but rising unemployment, consumer price inflation running ahead of earnings growth and the huge debt overhang. Now, in 2011, with job insecurity intensified after the spending cuts, the continuing debt issue and inflation likely to go up before it goes down, households will see the tax burden increase. Yet for all the assaults on their real purchasing power, consumers have been very resilient. There was a 3.3% fall in consumer spending in 2009, but in the 12 months to September 2010, a modest 2% bounce back. Although the VAT rise threatens to abort this recovery, several factors suggest the consumer will cope. First of all, continued low interest rates will keep debts manageable, consumer price inflation should ease as the year progresses and the UK’s VAT is relatively narrow, affecting less than two-thirds of consumer spending. And retailers can also help. Just as many did not pass on Alistair Darling’s VAT cut two years ago, so those concerned to maintain competitiveness and volumes may choose to absorb some or all of the VAT increase themselves rather than add it to price. Damaging as the tax increase might seem at this point in the recovery, the combined resourcefulness of consumers and retailers may offset the worst effects.