Clarke holds the key to retailers' reason to be jolly

Britain's consumers have returned to the shops with a vengeance. Retailers report that their sales got off to a roaring post-Christmas start, following record trade ahead of the Christmas weekend.

But we should not get carried away. It is a traditional Yuletide pursuit for chambers of commerce and department store public relations apparatchiks to vie with each other to paint the most enthusiastic picture. Hence the malls of Milton Keynes were described as 'full to overflowing', Birmingham city centre was 'jammed' and Bristol's Broadmead Centre 'choc-a-bloc'.

It remains to be seen whether the official high street spending figures for December, due next month, are quite as upbeat. If they suggest that shoppers were more restrained over the month as a whole, they will merely continue the recent trend in which December has accounted for a steadily falling proportion of sales for the year as a whole.

Barclaycard sounded a useful note of caution. It warned that although spending in the weekend before Christmas was 15 per cent up on last year, the rise was only half as great for the month so far. Mike McManus, commercial director of Barclaycard, said the pre-Budget sales surge had soon faded and that spending on the pre-Christmas weekend 'has not compensated greatly for the quieter times we have seen this month'.

Assessing Christmas trade has become increasingly difficult as consumers have left it later and later to buy their presents in the hope of finding last-minute bargains. This is just one manifestation of the way in which the recession has encouraged shoppers to be more canny, a change in high street psychology that is likely to endure for a good while yet.

This change in psychology has in turn forced a response from the retailers, who have found the old rhythms of the trading year disrupted. The summer and new year sales are not as distinct as they were, with price discounting increasingly an all-year phenomenon. Rumbelows is one retailer that has run an advertising campaign proclaiming that its new year sales not only begin before the new year, but well before Christmas.

The blurring of the distinction between sales and ordinary trading periods means that the official retail sales figures should be treated with considerable caution, as the adjustments made for normal seasonal changes may be out of date.

The graphic shows that, while the quarterly consumer spending figures have shown a steady recovery over the past two years, the seasonally adjusted monthly retail sales data (covering a smaller range of goods) have been much more erratic. Retail sales volume has risen in steps with heavy price discounting triggering a sharp rise in volume that is then followed by consolidation.

Sales volumes are assessed by adjusting the value of sales for changes in the prices of the goods sold. This can be difficult because price indices may not be accurate enough to reflect discounting fully. Discounting is often most dramatic in outlets that are under-represented in the surveys used to assess the price of the basket of goods bought by the average family - such as warehouse sales and shops selling bankrupt stock, for example.

Discounting is also more common in department stores than in single outlets with less financial muscle. This has meant that multiple retailers have gained market share at the expense of single shops, which may be distorting the measurement of the total volume of sales.

Price indices never provide a perfect way to calculate sales volumes, even when discounting is rare. The composition of the retail price index is changed once a year, based on the responses of 7,000 families questioned in the annual family expenditure survey.

Last year beef sausages, jam tarts and sterling silver St Christopher medals were removed from the index while cook-in sauces, bottled lager and Nintendo Game Boy computer games were included for the first time. But by the time the computer games were included they had already - in common with many new, hi-tech consumer electronic products - fallen in price.

Even notorious inflation hawks, such as the Bundesbank, believe that the slow response of price indices to changes in technology and tastes means that annual changes in these indices overstate the true rate of inflation by as much as 2 percentage points. The Treasury is not renowned for throwing money at the Central Statistical Office but it would not be surprising to see some well funded 'initiative' to improve the responsiveness of the inflation figures, perhaps by extending the variety of outlets surveyed or changing the composition of the index more frequently.

An enduring technical cut of 1 percentage point or so in the inflation rate would be a great help to the Treasury in keeping to its inflation target, while the intellectual justification for the change would be impeccable, so the CSO could hardly object. This change could also help to improve the accuracy of sales volume figures.

Given the erratic nature of the monthly retail sales data, the quarterly consumer spending component of the gross domestic product figures is a better (although still imperfect) guide to consumer behaviour. On this measure consumer spending rose by 1 per cent between the second and third quarters of the year and is now 2.6 per cent up on the third quarter of 1992.

The performance of the economy in the coming year will depend in large part on whether consumers can keep this performance up. The Treasury's November forecast that the economy will grow at its long-term trend rate of 2.5 per cent in 1994 relies heavily on the belief that consumer spending will rise by 2.25 per cent, slightly more than it is thought to have done in 1993. Most City and academic forecasters are more cautious, expecting consumer spending to rise by 2 per cent for the second successive year.

With employment and pay settlements likely to pick up only slowly in the coming months, the strength of consumer spending is likely to depend on the balance between two forces: the depressing effect of the Lamont/Clarke tax increases and any boost provided by the expected revival in the housing market.

It is a sad but unsurprising comment on the state of predictive economics that we have almost no idea how consumers will react to the tax increases. The best-case scenario is that consumers intelligently and with foresight react to the announcement of tax increases rather than their imposition.

This suggests that high street spending should not receive too great a setback when the tax increases are steadily phased in over the next two years, starting in April.

Last week's Gallup survey of consumers for the European Commission suggested that the Budget had already made consumers more worried about their personal financial circumstances and less willing to make big purchases.

But it is important to remember that consumer confidence also fell dramatically in the aftermath of Norman Lamont's March budget, only to rebound in the following month. This suggests that consumers may only be concerned temporarily when tax rises are announced and that the real belt- tightening will wait until they are imposed.

Kenneth Clarke's reluctance to cut interest rates again in the aftermath of the November Budget suggests that he may be keeping a cut in rates in reserve for April, when the first wave of tax increases (totalling more than pounds 8bn in 1994/5) hits wallets and purses. The uncertainty surrounding the measurement of consumer spending and retail sales may also be a reason for his caution.

But interest rate cuts take a long time to have their effect. If the consumer recovery is derailed by tax increases in April it will be too late to offset with cheaper borrowing costs. Mr Clarke should cut rates now.

(Graph omitted)