UK economy: consumer behaviour shifting as slowdown bites

Welcome to this PwC podcast, I’m Mark Hughes, an Energy & Utilities partner at PwC and with me today are John Hawksworth, the head of PwC Macro-economics, Robert Bolding, Director in our Market & Value Advisory practice, and Mark Hudson, our UK Retail & Consumer leader.

There have been some apocalyptic predictions made for the health of the UK economy recently and today we are looking to investigate what this means for consumers with the effects on personal liquidity, energy and the high street. Now John, what have been the most significant economic developments over the last month or so?

Well Mark, I mean there has certainly been some bad news; oil prices are continuing to rise globally, inflation is picking up – headline inflation 3.8% in June and nearly double the target which is making it very difficult for the banks to cut interest rates. At the same time, we’ve seen evidence in the latest purchasing managers surveys, both services and manufacturing are now seeing falling activity which is really a sign that some of the earlier problems in the financial markets and housing market are beginning to go more generally across the economy and beginning to.. even if we are not in recession yet, there is certainly a rising risk of recession to be concerned about. There is certainly a more gloomy picture than a month ago, but data remains somewhat mixed and we shouldn’t try to talk ourselves into a recession but it is certainly something that we need to be quite cautious about at this stage.

Now, you mentioned oil price rises there John, I mean how does that filter through to the general consumer.

Well, I mean obviously, it tends to also affect gas prices which tends to affect their heating bills and their domestic gas bills, which obviously comes through in petrol prices quite strongly, and of course it affects the whole range of goods you produce where oil is an input to it, so it really filters through the whole supply chain. We’ve got producer prices going up at 10% a year, although consumer prices are not going up that fast yet, some of that is going to have to be passed on to the consumers. Some of it will may be be left as a squeeze on profit margins, but certainly the environment is the most difficult we’ve seen since the early 90s.

So it’s a high priced market and is this going to fuel increases in interest rates, do you think?

Well I think the worry is that the bank, .. whether they will raise interest rates I don’t know, they might do particularly if there is any sign about feeding into wages and becoming embedded in the system, but it certainly seems to be preventing them from cutting interest rates, which is what they would normally want to do at this point in the economic cycle.

Rob, as a result of the downturn, are we seeing people using less credit?

I think you would expect in this environment, consumers to be borrowing less, when in fact in the first 5 months of 2008, up to May, Consumer credit on creditcards increased by 5%, compared to the same period last year. Yearh, so conversely, customers are becoming more dependent on credit cards and other forms of credit that they have, as they are faced with increased finance costs, particularly from Mortgages. And we saw the same in the US about a year ago, where customers were on heavily incentivised discounted products, they were then transferred onto the equivalent of standard variable rate, faced with significant increase in financing costs and they transferred that onto their credit cards to maintain their standard of living. So.. you see this waterfall effect of costs being passed down from one form of credit to another.

So what does this mean for retail sales, Mr Hudson?

At the beginning of the year we were anticipating a gradual decline, but not a precipitous decline in retail sales. What we saw going through the March, April and May period was the consumer actually starting to pool their spending, I suspect partly to do with maintaining their disposable income expenditure on things like their mobile phone or their Sky subscription and paying the higher costs of borrowing associated with their living expenses. I think what we have seen in more recent months, and you will see it from the announcements from the likes of Marks and Spencers and John Lewis, and Dixons and the failures of SCS in London, for example, is actually that consumers are tightening further in terms of retail spending, and the outlook from all of the retail commentators is particularly bleak between now and Christmas, with not a lot to get particularly exciting about.

And actually what we are also seeing from a leisure point of view, the businesses which were actually travelling particularly well in the early part of the year in the restaurant sector for example, I’m starting to hear from our clients that they are seeing reduced footfall and reduced spends per heads. So some of this is feeding through into the leisure sector as well as the retail sector. It’s not gone off a cliff, but instead of growing at 2% - 5% people are now at - 2% to -5% which has obvious implications.

So a big squeeze on consumer spending?

Yes, I think that as Mark says, people’s discretionary income, the amount they’ve got left over after they’ve spent the food bills and the domestic energy bills to fill their car with petrol, even though they may economize on that a bit, the amount of discretionary spending is going to be squeezed pretty hard at a time when prices are rising faster than earnings, so that real incomes are actually going down now. Although people are maybe using their credit cards a bit in the early part of the year, that cant go on for ever. People are going to reach the limit of that and they are actually going to have to start cutting back on spending and that is something now that we are factoring in more and more into our future forecasts and seeing very little real growth in consumer spending.

I think actually over the next year or so as well, customers are going to be faced with an increase in debt burden. Simply because over the last 2 or 3 years, there have been well over a million discounted mortgages provided to customers or very incentivized fixed rate deals and they are due to re-price over the next 18 months, and it is a very different mortgage market to a year ago, so they are going to have that initial shock of increased mortgage payments on a monthly basis, which they need to absorb either by decreasing expenditure in the high street or by using other forms of credit. So I think that could, you know, lead to other problems as well.

The first thing that customers are doing rather than stopping spending is switching spending. And what we are seeing is two things happening, both within specific retailers .. people are trading down through the architecture, so from the best to the better and from the better to the good. So that would mean from a Tesco point of view from the finest to the standard own label to the value lines. But also what they are doing is experimenting with the retail discounters such as the Aldi, Lidls and Nettos of this world, which have long tried to establish a foothold in the UK akin to what they have in say Germany or say Scandinavia. And those retailers are growing, in the case of Aldi at the rate of 25% at the moment. So consumers are changing their patterns of spending and trying value formats as well as reducing their consumption volumes at the same time.

So the supply side of the economy is adapting to the new spending.

I think another interesting thing, may be on the more structural level, is that consumers seem to be increasing their online spending. That seems to be one area that in official figures seem to be going up quite fast. At the same time as we are getting a cyclical downturn we are also getting a structural shift towards online spending, which is may be putting more pressure on those companies which are still focused very much on the high street, and perhaps haven’t got such a strong online delivery channel.

So the message here is, if you want to stay in business - “get cheap!”

Get cheap, get online maybe, but also, well – offer value for money I suppose rather than cheap per say.

I think you are absolutely right. The days of cheap and cheerful are long gone actually, I think you need to be cheap but high quality and sold in a high quality environment akin to a Primark, for example where actually Primark looks nowadays like Marks and Spencers virtually on the inside, but sells products at a third of the price. If you go to some of the more bottom-end value stores who are also selling cheap but in a bad environment, with bad sustainability track records then those businesses are generally failing.

So a challenging time ahead but there are structural changes that people are making to try to absorb these challenging times but we will have to see what happens over the next couple of years.
Well thank you for that gentlemen.

You can find more information about the current issues affecting the UK economy on our website: www.pwc.co.uk.
Thank you for listening!