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Surprise drop in UK Retail Sales

Following yesterdays’ cautious assessment from the Bank Of England sterling dipped after a good run. The dip in sterling yesterday was not significant (1% against the euro and 0.8% against the USD) but it does dampen recent expectations of targeting 1.20 on the EURO and 1.70 against the USD. Data just released in the form of UK retail sales was much worse than expected falling 0.6% month on month against a forecast of a 0.4% rise … this brings the fall in retail sales to -1.6% on a year on year basis! The fall in retail sales is a big surprise and bucks the trend of recent gains on retail sales in April and May … the fall has been attributed to poor sales of clothing, footwear and by department stores. It is worth noting that online retail sales posted the slowest growth rate in the surveys nine year history dropping 3.5% from April’s level- this identifies that both on the street and on-line sales are suffering as the economic slowdown maintains its hold with consumers. Sterling dipped sharply on the news against across the markets dropping a full cent against the US dollar and 0.6% against the euro. David Blanchflower (former MPC member) warned that we have yet to realize how painful economically the next few years will be, Blanchflower’s opinion is well regarded as he was one of the few voices warning of the full economic impact of the sub-prime fall out before the reality of it kicked in. Mervyn King, in a speech at Mansion House emphasized the need for a clear plan to reduce deficits in the next parliament; this will be key for the future performance of sterling and the USD as concerns are mounting on bulging debt - lack of a clear plan to reduce this debt will lead to weakness in the USD and the pound. On to regulation…Alistair Darling in his speech called for banks to focus on long term wealth creation and not short term profits, noting that the process of learning has to start in the boardroom- this is fine rhetoric but can it be assured? Mervyn King wants the Bank Of England to have more say in financial regulation contrasting to Darling’s view that the current system is adequate. Similarly in the US Barack Obama in between swatting flies has come up with some new proposals to try to safeguard the US economy from a repeat of recent issues. The theme of the proposals was to increase power and accountability for the Federal Reserve and to get banks to raise additional capital going forward. Whilst the regulatory discussion are not having a direct bearing on the markets- it is critical that this dealt with along with spiraling debt in order to increase confidence in the UK and US economies moving forward. Looking at the USD we did see some weakness in trading yesterday as lower inflation data essentially underlined the necessity to maintain interest rates at low levels for some time to come. In other news a report in Australia showed that the Reserve Bank of Australia sold over I billion AUD in May to try to suppress the strength of the currency- this just shows the demand for the AUD as a higher yielding commodity currency in the last month.

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