Low inflation, cheap oil and increased consumer confidence should help bolster UK economic growth in the final quarter of this year and next year.
The latest data on the volumes of retail sales suggest low inflation and falling petrol prices helped increase spending during the first two months of the final quarter.
After slowing significantly from a 1.9% rise in the second quarter to just 0.5% in the third quarter, retail sales bounced back again in the fourth quarter. Even though the December sales data may come in weaker when compared with 'Black Friday' bolstered November, the total fourth-quarter sales should come in stronger.
UK shoppers have been enjoying massive discounts ahead of the festive season, while cheaper petrol has given the buyers' appetite a healthy boost too. Inflation deep below the official target of 2% and the record positive outlook of UK households for their personal finances also added to the sentiment.
On the impact of falling oil prices on the UK economy, Bank of England (BoE) policymakers judged in December that "in net terms, that the reduction in the oil price would, if sustained, act as a stimulus to growth in the United Kingdom and its main trading partners via its effect on the costs of production and real incomes."
On fourth quarter growth expectations, the BoE said that "short-term indicators suggested that underlying momentum had been sustained into the fourth quarter. Bank staff expected GDP growth of around 0.6% in Q4, with the risks to that expectation probably to the upside.” In its November PMI surveys, Markit Economics said it expected a 0.6% growth in the fourth quarter."
Due to external price pressures being suppressed significantly, inflation in the UK is expected to fall temporarily below 1%, possibly in December, or within the next six weeks, according to the BoE estimate.
Commenting on those economic developments, Berenberg bank chief UK economist and former BoE official Robert Wood said that "the oil price rout is like a big tax cut for consumers, and UK consumers tend to spend extra income. They also evidently like price deals in the shops."
Wood also said that it was "unlikely that falling oil prices will induce a deflationary mindset among consumers … Those downside risks from falling oil prices are overplayed, especially in the UK. In our view, now is the time to be optimistic about the UK. A tax cut funded by Russia and Middle East and falling mortgage rates should combine in a powerful cocktail that boosts UK growth next year."
One of the risks on the downside is next year's general election, due in May. Market participants will be nervously keeping their eyes on the bickering politicians. The increased level of anti-European Union rhetoric and anti-immigration sentiment ahead of the polls suggest those topics may seize the pre-election frenzy and nervousness among investors may rise subsequently.
While the data suggest the UK economy continues to hold momentum, market expectations of the first hike in the BoE's base interest rate have been pushed back towards late 2015 following a dovish Inflation Report in November and the subsequent comments from BoE top officials. However, some market participants argue those late expectations are overblown and that the BoE may begin to hint at rate hike sometime early next year before a first hike in August.
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