Consumption growth prospects remain strong

Investor: Consensus views of interest rate and inflation trends have undergone several twists and turns this year.

Rampant oil and commodity price rises up to late summer generated significant increases in headline rates of inflation across the globe. The recent drop in oil price in particular is already beginning to have a dampening impact on consumer price indices. However, this relief on the inflation front is not feeding through to lower interest rate expectations.

In the US, this is due to the fact that the core rate of inflation has only come down marginally. More importantly, the US economy is proving to be resilient despite the sharp slowdown in the housing market. In fact, the evidence is mounting that the US consumer has been almost immune to the deterioration in housing.

Excluding petrol sales, the most recent retail sales data revealed strong growth. Furthermore, the University of Michigan survey of US consumer sentiment reported that consumers' assessment of both current and future conditions improved in October by more than expected.

In light of such resilience in the economy, recent statements from Federal Reserve governors are being interpreted as indicating that the Fed will be slow to cut interest rates.

By year end, Investor expects US interest rates to be unchanged at 5.25 per cent, and to be a quarter point higher in the UK and euro zone at 5 per cent and 3.5 per cent respectively. For the first half of 2007, the odds still favour a further increase in euro rates with an outside chance of another rise in the UK. The most likely outcome in the US is that the Fed will maintain the official interest rate at its present level.

The current economic scenario is being referred to as the "Goldilocks" scenario in some quarters, which describes a situation where the world economy enjoys a solid rate of economic growth that is not so fast as to put unacceptable upward pressure on inflation. In this environment, it only takes modest interest rate increases to provide the necessary touch on the brakes to keep growth and inflation on sustainable trajectories.

In the Republic, there has been some comment regarding a possible slowdown in the housing market. The evidence so far is mainly anecdotal, based it would seem on the failure of many properties to sell at auction.

The more important price surveys of the entire market have reported a slight slowdown in the pace of house-price inflation.

Investor expects house-price inflation to slow gradually over the next year as the cumulative rise in interest rates bites. The risks of a sharp slowdown remain extremely low given the ongoing employment gains and wage rises in the economy. Add in a pre-election Budget and maturing SSIA funds, and it is clear that the broader economy can easily cope with a slowdown in the housing market and further interest rate increases.

In fact, recent economic data releases indicate that Irish consumer spending continues to grow at a healthy pace despite the impact of interest rate increases over the past year.

In August, retail sales grew at an annual rate of 5.7 per cent, which was a little faster than the July out-turn of 5.3 per cent. Growth has slowed down from May to June but this moderation can be attributed to a fall-off in the rate of growth in car sales.

Other categories of consumer expenditure are performing quite well, with strong increases in sales of high-street items such as clothing and footwear. The rate of increase in sales of hardware goods moderated slightly in August to a 9.4 per cent year-on-year rate compared with 9.8 per cent in June. There has been a more marked slowdown in the sales of furniture and lighting to a rate of 4.1 per cent compared with 12.7 per cent in May. If the housing market does slow, then growth in these categories is likely to continue to moderate.

However, with the bulk of SSIA funds still to be released, car sales could well pick up any slack in other categories of consumer expenditure going into 2007. For 2006, consensus forecasts for real consumer expenditure hover at a rate of about 6.5 per cent. Even factoring in a slowdown in housing-related categories, the prospects for another year of strong consumption growth in 2007 remain good.

The broader economy can easily cope with a slowdown in the housing market and further interest rate increases.

In fact, recent economic data releases indicate that Irish consumer spending continues to grow at a healthy pace despite the impact of interest rate increases over the past year.