Retail sector health unexpectedly robust in first quarter of 2022, but rising costs could prove tipping point ahead warns Retail Think Tank

The health of the retail sector remained robust in the opening three months of the year, as consumer demand slowed less than expected, according to the latest assessment by KPMG/Ipsos Retail Think Tank (RTT) members. 

Reported retail sales growth over the quarter was stronger than expected by RTT members, driven by non-food categories as consumers replenished wardrobes for social events and a return to the office. Following a better-than-expected sales performance in January, demand at grocers slowed towards the end of the quarter, signalling consumer demand could be on the slide as the cost-of-living crisis takes hold. 

Despite a rising cost agenda and flat margins, solid consumer demand saw the Retail Health Index (RHI) flat at 75 points in Q122 equalling the score recorded in Q319 – months before the pandemic hit. But the RTT predict that the health of the sector will deteriorate in the next few months as retailers are hit by a tsunami of costs and falling consumer confidence. 

Commenting on the RHI for Q122 Paul Martin, head of retail at KPMG in the UK said: “Against the background of the rising cost of living , consumers continued to head to the high streets in the first quarter of the year, helping retailers to offset their own rising costs driven largely by labour, supply chain and cost of goods increases. Despite the headlines, we are seeing increased footfall to bricks and mortar retailers and people are choosing to spend more time in physical retail as they continue to treat themselves following two years of restrictions. 

“The stronger than expected consumer demand was driven by the non-food sector with grocers already seeing consumer demand falling. Towards the end of the quarter sales growth was less robust, particularly in the food and drink sector with many consumers trading down on the brands they shop for and discounting starting to creep in.  However, figures could be lower than last year given Easter fell later this year. These are all signs that confidence is falling and with many retailers now starting to raise prices to protect margins, the clouds are on the horizon for more muted health for the retail sector in the coming months.” 

However, the RTT does not believe that consumer demand will decline considerably over the next few months as the Retail Health Index pointed to some consumers choosing to use savings amassed during lockdown or buy now pay later debt to fuel continued demand. 

Ruth Gregory, Senior UK economist, Capital Economics, observed:“The drop in the household saving rate from 7.5% in Q3 to 6.8% in Q4 shows that for those households that are able to, they are willing to save a smaller share of their income to keep spending. The £4.0bn rise in cash sitting in UK households’ bank accounts in February, which was smaller than the 2019 average rise of £4.6bn, suggests that households have stopped adding to their excess savings and have begun to reduce them. The stock of excess savings is now estimated to have fallen from £161.8bn in January to £161.2bn in February. The £1.9bn leap in consumer credit in February suggests households may also be turning to credit to tide them over. In the months ahead, some of the squeeze on households’ real incomes will be dulled by employment and earnings rising further. And while excess savings are skewed towards the upper end of the income distribution, consumers may still be able to raise their spending a bit by reducing their stocks of excess savings built up during the pandemic and/or borrowing more to continue shopping. So, over the coming months, there is scope for consumer spending to continue to rise as real incomes fall. Clearly, though, the longer the drag on households’ real incomes lasts, the more likely it is that households change their spending behaviour” 

Tsunami of costs could derail retail health in Q2

Despite a relatively strong start to the year, the RTT is predicting that the health of the sector will fall by one point as we move into Q2. Retailers are facing a tsunami of rising costs in the next quarter including the return of full business rates, utility hikes and a national insurance increase. The RTT believe this will cause margins to face more pressures and coupled with potentially weakened consumer demand and no longer being able to absorb rising costs, it could be a difficult quarter for the retail sector. This negative impact, which is driven primarily by cost rather than falling demand, could be a more permanent blow to the industry than a mostly demand driven decline, which is more flexible and can be reversed more quickly. 

Martin concluded: “The retail sector has a bumpy few months ahead as cost pressures start hitting from many directions.  In addition to the domestic economic conditions, the conflict in Ukraine and lockdown in China is expected to lead to rising food prices, both through higher fertiliser costs and wholesale food prices, as well as increased prices of some metals and other commodities and continued supply chain issues. 

“Whilst pent up demand and household savings mean that we do not expect consumer spending to fall back completely, there will be strong competition from hospitality and leisure as the weather improves, which will result in further spend being diverted from the retail sector. 

“The two biggest areas of short-mid-term focus for UK retailers will be cost-efficiency, alongside  operational resilience. The next quarter could be challenging for retail with many competing priorities, although it is likely the longer we see high inflation and real household incomes falling, the greater the chance that consumer spending will also fall. Whilst we expect the health of the sector fall by one point in the next quarter, Q3 and Q4 could be an even greater challenge.”