Meteoric rise in retail sales baffles City

UK retail sales rocketed by 3.5% during March alone, a rate which would annualise to 42%, according to official figures yesterday which have a strong claim to being the most astounding economic data in recent years.

The City had predicted a 0.1% fall in sales volumes last month.

The actual 3.5% rise was the greatest since the retail sales data series began in 1986, the Office for National Statistics noted. It is all the more incredible given the significant squeeze on household finances coming from soaring petrol prices, hikes in electricity and gas bills, and rising mortgage costs. Clothing sales surged.

London-based consultancy Capital Economics, looking at similar data going further back, noted it was the biggest month-on-month jump since June 1979.

Yesterday's retail sales data immediately give fresh impetus to talk of a rise in UK base rates from their level of 5%.

However, Bank of England Governor Mervyn King emphasised in his speech at the Mansion House in London on Wednesday night that he expected stagnation of real take-home pay and the impact of the credit crisis to hit the high street significantly this year.

This suggests it will take more than a single month's retail sales data, albeit figures which show an astonishing rise, to move the Bank's Monetary Policy Committee to a tightening bias.

That said, it makes the fast-disappearing chances of a near-term cut in base rates even slimmer.

The MPC has cut UK base rates by a quarter-point three times this cycle, in December, February and April.

Sir John Gieve, deputy governor of the Bank of England, appeared at pains to quell fears of any imminent rise in UK base rates in a speech last night in the north-east of England.

Gieve highlighted housing market weakness and added: "There are ... signs in some of the more timely survey indicators of consumer spending that weakness is spreading there too."

He declared: "If nothing else were going on, the MPC would expect this prospective weakness in overall demand to put downward pressure on inflation in the medium term and that would be pointing to further rate cuts."

Gieve added swiftly that "there is something else going on", citing the "huge increase in oil and food prices".

And he echoed King's warning on Wednesday night that wage and price-setters must show restraint.

However, it appeared notable that Gieve mentioned the notion of further rate cuts, albeit then citing the barrier to such moves, and did not specifically mention the notion of a rise.

And, highlighting the potential knock-on impact of housing market weakness, he said: "The belief that in housing you could have your cake and eat it - that is your house would not just provide a place to live but would also provide an assured capital gain - has become widespread and the shock to expectations appears to be having a wider impact on confidence."

The seasonally adjusted rise in sales of 3.5% last month sent the year-on-year increase accelerating dramatically from 3.8% in April to 8.1% in May.

This year-on-year increase in May was the greatest since April 2002.

The leap in retail sales during the month of May was broadly based.

The food sector showed a 3.3% month-on-month jump in sales - the biggest increase since directly comparable records began in 1986. Non-food sales were up an even greater 3.9% - the largest month-on-month increase in this category since March 1991.

Sales in the textiles, clothing, and footwear category leapt by 9.2% during May -the biggest month-on-month jump in this category since the data series began in 1986.

Howard Archer, chief UK economist at consultancy Global Insight, said: "These retail sales figures are absolutely astounding, even allowing for the fact that food and perhaps the better weather lifting clothing sales were major factors.

However, this was by no means the whole story as there was strength elsewhere. The data seem totally at odds with the survey evidence and with consumer confidence standing at an 18-year low."

Citing recent surveys from the Confederation of British Industry and British Retail Consortium, Archer added: "Although the CBI and BRC surveys had indicated there had been some pick-up in retail sales in May after muted performances in April and March, they did not suggest that growth was anything like this.

Furthermore, the Bank of England's agents reported in June that consumption growth had eased further, and was at its weakest pace since the autumn of 2005'."

The retail sales deflator in yesterday's data suggested prices in May were only 0.3% lower than in the same month last year - the least negative out-turn since June 2007. It had in April indicated a 1.0% year-on-year fall in prices, and the May number signals retailers are gaining pricing power.

Archer said: "While prices were lifted by sharply higher food prices, it does also suggest that retailers are trying to pass on more of their elevated costs - which will be a concern to the Bank of England."

He added: "The Bank of England is likely to treat the retail sales data with a great deal of caution, and it has recently expressed doubts as to their reliability. Nevertheless, the sheer strength of the rise in retail sales in May and the pick-up in the deflator clearly shortens the odds of an interest rate hike before long."

Ben May, UK economist at Capital Economics, said: "May's whopping rise in UK retail sales will certainly keep talk of possible interest-rate hikes alive."

Noting the retail sales data were "dramatically stronger than much of the survey and anecdotal evidence suggested", May added: "The rise was broad-based, although clothing sales recorded a particularly sharp increase after disappointing sales in March and April."

He said May's rise meant growth in retail sales volumes during the second quarter as a whole were likely to be broadly in line with the healthy 2.0% rise during the first three months of this year.

May added: "Even if sales fell by 2% month-on-month in June, this would leave sales 1.5% higher in Q2 as whole."

However, he cautioned: "Given the backdrop of sharply rising inflation and plummeting confidence, we continue to think that the official sales figures should be taken with a pinch of salt."