U.K. Retail Sales Drop in March as Inflation Hits Consumers -- Update

U.K. retail sales dropped sharply in the first quarter of the year, as accelerating inflation began to crimp household budgets, new data showed.

Consumer spending has been a key engine of U.K. economic growth and signs that it is starting to stall comes at an awkward time for Prime Minister Theresa May, who this week called a surprise early general election for June 8.

Announcing her decision, Mrs. May highlighted the U.K.'s surprising economic strength in the wake of the U.K.'s vote to leave the European Union, saying growth has "exceeded all expectations" since Britons chose to leave the bloc in June last year. Official data show that the U.K.'s better-than-expected economic performance was underpinned largely by consumer resilience.

But the first three months of 2017 saw a sharp decline in retail sales, which fell by 1.4% on the earlier quarter after adjustment for regular seasonal fluctuations, the Office for National Statistics said. That was the largest drop in seven years.

It means retail sales subtracted from the U.K.'s quarterly economic growth for the first time since late 2010, shaving 0.1 percentage points off the first-quarter figure, the ONS said.

In March alone, retail sales fell by 1.8% on the month, significantly more than the 0.1% fall forecast by analysts polled by The Wall Street Journal. Compared with March last year, sales were 1.7% higher, also significantly below analysts' expectations.

"This is the clearest indication yet that the expected slowdown in the U.K. economy has begun," said Andrew Sentance, senior economic adviser at PwC in London. An official estimate of the U.K.'s economic growth in the first quarter is expected next week.

Inflation in the U.K. has gained pace in the wake of the Brexit vote, and prices continued to rise at the fastest pace in over three years in March, fueled in part by the pound's sharp post-referendum depreciation.

Despite a robust labor market, with unemployment at levels that were last lower in the mid-1970s, Britons' wages after inflation grew only modestly the start of this year. That suggests British workers are now facing a living-standards squeeze and are likely to watch spending closely in coming months.

The Bank of England expects inflation to peak at around 2.75% early next year, and Gov. Mark Carney has signaled that he is prepared to tolerate an overshoot of the bank's 2% target if it helps keep the economy on an even keel while Mrs. May negotiates the U.K.'s EU withdrawal.

However, a member of the committee that sets interest rates Friday indicated he may break ranks with the majority and vote for a rise in the key interest rate in May, since he expects a rise in exports and higher business investment to offset any slowdown in consumer spending.

"Overall, I suspect that the next year or two will see steady growth, above-target inflation, stronger exports, and a pickup in business investment," said Michael Saunders, one of four rate-setters who don't work at the bank full-time.

Proponents of Brexit say the U.K. economy will flourish once the country is out of the EU through new trade deals and by cutting red tape. They argue that the pound's depreciation is likely to boost exports and could go some way toward rebalancing the U.K. economy, which so far has relied largely on domestic demand for growth.

Earlier this week, the International Monetary Fund raised its forecast for U.K. 2017 growth, reflecting "the stronger-than-expected performance of the U.K. economy since the June Brexit vote." But the fund said it still expects the referendum decision to bear down on growth, albeit more gradually than previously thought.

Write to Wiktor Szary at Wiktor.Szary@wsj.com

(END) Dow Jones Newswires

April 21, 2017 09:10 ET (13:10 GMT)