Windfall inflation fear

ECONOMICS - THE WEEK IN VIEW

SHAREHOLDERS in the newly-floated Alliance & Leicester bank enjoyed a profitable week but their good fortune has left economists worried that this summer's windfall gains will cause consumer spending to soar, taking inflation with it.

The size of the windfall payments from building societies and other financial institutions dwarfs any previous payouts in the 1980s many times over. A recent MORI survey showed that roughly one-third of the adult population aged 15 and over will receive some of these windfalls. The average expected windfall is just below pounds 1,200.

In total, consumers will receive about pounds 21bn over the next few months, which is the equivalent of 4 per cent of annual consumer spending, or a temporary 11p cut in the basic rate of income tax. Depending on how much of this is spent rather than saved, the knock-on effect on capacity use, prices and the current account could be massive.

The problem for economists is that it is impossible to predict how people will behave but if the experience with A&L is repeated, their initial estimates have been over-cautious.

When trading began in A&L on Monday, 27 per cent of the shares were sold but such was the demand from institutional investors the price soared to 566p, way ahead of expectations.

The percentage of people selling these shares would rise to 50 per cent if prices rose sharply, estimated Salomon Brothers on the basis of the MORI survey.

Retailers of clothing and household goods - precisely the items on which windfall gains may be spent - have already begun to increase prices, noted Jeremy Batstone at NatWest Securities. Most recent figures show that prices of clothing and footwear rose 2 per cent during March from a year earlier, while the cost of household goods jumped 2 per cent during the same period.

"There's a hedonistic tendency, so a lot of what will be spent is likely to go on holidays or big ticket items," said Adam Sinclair, project manager at MORI, who helped conduct the survey.

Travel agent Thomas Cook said sales of summer holidays are 28 per cent higher this year.

"There's no doubt that the windfall gains are encouraging people to spend more," said Vicki Burwell, public relations officer at Thomas Cook. "Customers are choosing more exotic destinations. Florida and the Caribbean feature in the top ten destinations this year and this has not been the norm."

The prospect of a large proportion being spent on holidays is likely to widen the UK's current account, effectively a ledger of a country's debits and credits, said Michael Saunders, UK economist at Salomon Brothers.

Saunders thinks the bulk of the windfalls will be saved. Bigger payouts will accrue to those who are middle-aged and richer - people more likely to reinvest their gains.

Converting building societies are also offering increasingly attractive saving deals in an attempt to retain customers. A&L last week launched two new savings accounts aimed at offering higher interest rates.

"There is a divide between windfall recipients along the lines of age and wealth, and small-time investors are less inclined to save than those with more money," said Mr Sinclair.

As 70 per cent of A&L savers hold pounds 2,000 or less, A&L's flotation may exaggerate the proportion of shares sold, explained Mr Batstone.

Windfall income will generally be reinvested, according to Simon Briscoe, economist at Nikko Europe. "Holidays and home improvements do not fully feature in the retail price index. The narrowness of this boost to consumer demand means the corresponding boost to inflation will be less."

There is no reason to believe windfall recipients will alter their price- sensitive behaviour in their day-to-day activities, he said. Copyright: IOS & Bloomberg