Sterling fell sharply as the City reassessed the chances of an early increase in interest rates
You don't need to be a genius to work out what is happening to the UK economy. Indeed, Tuesday's inflation figures and the high street spending report from the British Retail Consortium (BRC) tell you everything you need to know.
What's happening is that consumers are taking a fearful battering from rising taxes, lower public spending and pay rises that are running well below the inflation rate. They are fearful of losing their jobs and far from using their homes as cash dispensers as they were during the housing bubble in the middle of the last decade, they are now paying chunks off their mortgages whenever they can.
Put simply, many consumers are feeling skint. The fact that it now costs upwards of £60 to fill up a car at the weekend means spending on books, furniture, clothing and footwear and entertainment is being squeezed.
Retailers have seen their costs rise over the past year. Higher commodity prices mean that they are paying more for the goods they buy from wholesalers and spiralling oil prices mean they are paying more for lighting and heating at their stores. They would dearly love to pass on these higher costs to their customers, and have been trying to do just that in recent months. The pass through from this year's increase in VAT from 17.5% to 20% was more marked than it was when VAT rose from 15% to 17.5% at the start of 2010.
But the evidence from the past few weeks – in the downbeat trading statements from individual retailers, the monthly snapshots of demand from the British Retail Consortium and now the inflation figures – is compelling. Consumers have gone on a buying strike; they are now longer able or prepared to shell out £100 for a dress or £40 for a computer game. Retailers have got the message and have reluctantly started to accept that prices – and hence profit margins – will have to be cut to keep business volumes up.
Last month, according to the BRC, the value of retail sales was 3.5% lower than a year earlier on a like-for-like basis, which takes account of the increase in floor space added by retailers over the past year. This was the weakest report since the BRC began putting out monthly releases in the mid-1990s, and was reflected in the fall in inflation from 4.4% to 4%.
This does not mean that inflationary pressure is now going to abate steadily month after month. Oil and commodity prices are still rising and will have an impact on the cost of living over the spring and summer. But it does suggest that fears of inflation hitting 5% may be a bit overdone.
There is good and bad news in all this for George Osborne. The good news is that the inflation data and the BRC report provide powerful ammunition for the doves at the Bank of England. Sterling fell sharply as the City reassessed the chances of an early increase in interest rates. The betting now is that Threadneedle Street will not move until August at the earliest.
The bad news for Osborne is that he appears to have been far too optimistic about the ability of the economy to cope with a fiscal tightening averaging 1.5% of national output in each of the next four years. The austerity programme only began in earnest this month and comes at a time when, despite better news on exports, the economy looks highly fragile.
It speaks volumes that after more than two years of holding interest rates at the emergency level of 0.5% the Bank is wary of raising borrowing costs when inflation is double the government's 2% target.