UK Retail Sales (MoM) (DEC) (09:30 GMT; 04:30 EST)
Expected: 0.2%
Previous: 0.4%

UK Retail Sales (YoY) (DEC) (01:30 GMT; 19:30 EST)
Expected: 3.4%
Previous: 4.4%

What Are The Markets Facing?

Retail spending in the UK is anticipated to slow during the month of December to 0.2 percent, while the annual rate of growth is forecasted to hit an 11-month low of 3.4 percent. The data would be in line with the British Retail Consortium’s (BRC) December survey, which indicated that mounting energy prices and deterioration in the housing sector led sales to only rise a tepid 0.3 percent from last year. On the other hand, UK retailers such as HMV, Home Retail Group, Kesa Electricals, and Primark reported stronger-than-expected figures that suggest the headline retail sales report could be a bit better than forecasts. Furthermore, labor market conditions remain extremely resilient, and average earnings in November surprisingly held steady at 4.0 percent (they had been expected to ease lower). However, it may only be a matter of time before the UK consumer will cut back on discretionary spending drastically, especially as the effects of the Bank of England’s tightening cycle in the earlier part of 2007 comes into play. Indeed, Bank of England Deputy Governor John Gieve said on Thursday, “Growth is slowing quite sharply now, in part because of the rises in interest rates last year. That in itself might justify a progressive shift in policy from restrictive to a more neutral stance." Gieve notes a “neutral stance” rather than an accommodative one, as he also noted that accelerating food, petrol, gas and electricity prices are likely to push the “inflation rate well above target in the coming months at a time when short-term inflation expectations remain uncomfortably high.” As a result, the Bank of England is likely to leave rates steady at 5.50 percent in February, but the monetary policy committee’s bias remains a dovish one and the markets are betting they will cut rates down to 4.75 percent by the third quarter.

Bonds – 10-Year Long Gilt Futures

On a short-term basis, Gilts have recovered quite a bit from trendline support, but there are still indications that the contract has topped out. Given the UK event risk on Friday, Gilts could tumble through noted support towards 110.25, as retail sales are forecasted to improve. Furthermore, BOE Deputy Governor Gieve’s recent commentary suggests that rate cut expectations for the bank may be overdone, and Gilts may respond accordingly in coming days.

FX – GBP/USD

The GBP/USD pair has done nothing but consolidate losses since running into support at the 1.95 level, though it has managed to push above 1.97, which lends a bullish bias. Meanwhile, DailyFX Technical Strategist Jamie Saettele noted recently that Cable may have formed an intermediate bottom, and that the pair could rocket higher towards the 2.00 level. However, the release of UK retail sales on Friday could weigh the British pound down, as the figure is anticipated to show that consumption growth slowed during the month of December. However, if the data proves to be better than expected, the news could actually lead Cable to trek higher. Moreover, with aggressive rate cuts by the Bank of England already priced into GBP/USD, the declines may be overdone and the pair could respond more severely to slightly bullish economic figures.

Equities – FTSE 100 Index

The FTSE 100 has run into support at 5,900, as instability in the US and European financial markets take a toll on UK equities. While the longer-term trend for UK stocks are to the downside, the index could stabilize and consolidate above this level and the release of UK retail sales may help. Indeed, the most recent reports from retailers have proven to be strong, which helped lift retail-oriented shares on Thursday. However, if the UK retail sales report proves to be disappointing or other dismal news hits the financial markets (like news of Merrill Lynch’s Q4 loss of almost $10 billion), the FTSE 100 could continue to descend towards 5,800.

Terri Belkas is a Currency Strategist at FXCM.