The heat is on the retail sector…

The heat is on the retail sector…

‘Flaming June’ has finally arrived, with temperatures reaching 27 degrees in the capital today.

I’m sure many of us will be hoping to be able to get out into the great British summer as, knowing our luck, today might constitute the whole thing.

One group hoping the hot spell doesn’t last are the retailers. Good weather traditionally depresses footfall along high streets and in shopping centres, as consumers pursue other leisure opportunities.

Though traders in seaside resorts, and the owners of riverside pubs and restaurants will anticipate a busy day ahead.

These trends in consumer behaviour are part of what is known as ‘seasonality’ and it’s one of the constant challenges faced by retailers of all shapes and sizes.

But the weather is perhaps not the greatest challenge facing UK retailers right now. In fact, it’s heat of a different kind that poses a threat…

You see, the temperature is rising as far as inflation is concerned…

The Bank of England spent much of the last decade trying to stimulate inflation in the UK economy.

Modest positive levels of inflation were seen as being desirable, as they would help drive recovery by, quite literally, reflating the economy.

After all, one definition of inflation is that it represents the excess demand for goods and services in an economy. And demand is good, right?

The Bank of England’s inflation target is 2%, but yesterday we learnt the UK Consumer Price Index (CPI) had risen by +2.9% during May – up from +2.7% in April.

From the Bank’s point of view it’s a headache, because not only is the number well above its target, there is also clear evidence of a rising trend in the CPI figure.

It wasn’t entirely unexpected, because it was clear some inflation would be imported into the UK, as the pound fell in value on the foreign exchanges (simply because we had to pay more for our imports).

However, the hope had been that the jump to +2.7% – seen in April’s inflation data – would be the peak and that we might see stabilisation and a gradual decline, as consumers moderated their behaviour and supply chains adjusted (perhaps by seeking to replace imports with locally available alternatives).

If this has happened it’s not being reflected in the CPI figures.

And that’s an issue for retailers, who basically have two options: Raise prices or accept lower margins, or profits.

For now at least, and probably for the foreseeable future, wage rises in the UK are not keeping pace with price rises, which inevitably means consumers will have less to spend.

Retailers are being squeezed – right where it hurts the most…

Raising prices in this environment is not an attractive proposition for retailers of any hue.

The market place in items such as food and groceries, consumer electricals, and clothing might be described as cut-throat – such is the level of competition…

So raising prices might mean you miss out on getting a sale, whilst a competitor who hasn’t raised their prices will get that business.

But here’s the catch…

Profit margins for many retailers are thin as it is.

A combination of high rents and business rates, an increase in the minimum wage, plus fierce competition have squeezed businesses from giants like Tesco right down to the corner shop, to the point where thinner margins may not be sustainable long-term.

For instance, it’s my understanding that Tesco will in future be looking at margins of just 3%.

There’s not much room for error in those figures, and given the complexity of their supply chain and the fickle nature of UK shoppers, there’s plenty of room for problems along the way.

Despite recent problems though, Tesco is rightly considered a byword for efficiency, in a business sense.

It will be hard for other retailers, particularly mid-market players and those lower, to come close to running a business as well as them.

The challenges rising prices present to retailers are not just confined to the bricks and mortar variety…

Whilst it’s true that online retailers don’t have the same overheads as those on the high street, they face their own issues.

For example, among online clothing retailers returns are becoming an issue, with as many as a third of items (or in some cases more) purchased being returned.

Usually the cost of those returns falls to the retailers, who subcontract the delivery and collection to specialist couriers, who themselves are subject to price pressures and inflation (for example in fuel costs, which have been rising again as a result of the weaker pound).

Slower consumer spending data seen in May and the rise in inflation have meant the FTSE 350 General Retail sector has given back all the gains it’s made in 2017 so far. It is now down on the year by 0.9%.

Food and drug retailers are faring even worse – down by -1.8% year-to-date.

Against this background, Thursday’s Bank of England meeting to decide what happens next to UK interest rates takes on greater significance.

Rising rates would hike up mortgage payments and squeeze both consumer spending and retail profit margins further.

Expectations are for no change in the actual numbers, but there may be some indication of how the Bank sees things evolving into the year-end for prices, the economy and interest rates.