Strong retail rebound adds to the MPC's dilemma – EY ITEM Club comments

• Retail sales grew strongly for a second successive month in February, raising hopes that the near two-year decline in sales volumes is now at an end. A recovery in real incomes is expected to provide some momentum to the retail recovery in the second half of this year. 

• However, the strength of today's data will add to the Monetary Policy Committee's (MPC) dilemma. The resilience of activity was cited as a reason why the MPC increased rates again yesterday. Although the EY ITEM Club thinks that interest rates have now peaked, if the data continues in a similar vein over the next month, some MPC members might feel compelled to vote for another rate rise in May. 

Martin Beck, chief economic advisor to the EY ITEM Club, says: “Retail sales rose by 1.2% month-on-month in February, for a second successive large rise. And though this followed a substantial fall in December, sales volumes in February were at their highest level for six months. Of the four main sub-sectors, only fuel retailers reported a month-on-month fall in sales.

“The stronger retail data comes on the back of February's surprise rebound in the Purchasing Managers’ Indices (PMIs) – with March's flash survey to be published later this morning. Together, the data is consistent with the MPC's argument that the pickup in activity has preceded the improvement in household spending power that will be brought about by the recent fall in wholesale energy prices. The EY ITEM Club thinks that the MPC has now done enough and that Bank Rate will peak at 4.25%. However, with the MPC placing a renewed focus on the strength of activity and the tightness of the labour market, strong outturns like today's raise the chances that some members might vote for another increase in interest rates in May.

“However, it’s encouraging that, after a tough couple of years for retailers, sales now appear to have passed the bottom and the recovery will likely strengthen as we move through 2023. Notwithstanding this week's upside surprise, inflation should soon start to fall back at pace, eventually falling below wage growth in the second half of the year. The labour market remains strong, with unemployment at very low levels. And recipients of state benefits will enjoy a large increase in their payments from next month, when the latest inflation uprating comes into effect. It's not all good news though, with the impact of higher interest rates on spending power likely to escalate as fixed rate mortgage deals end. We should, however, see household incomes begin to rise again in real terms in the second half of 2023. This, in turn, should provide some momentum to the retail recovery.”