Industry edges upward after soft landing: after avoiding recession in '89, better '90 ahead - discount store industry

Discount Store News, Nov 13, 1989 by Richard Mount

Industry Edges Upward After Soft Landing

The economy has successfully navigated the narrow straits between recession and inflation in 1989, achieving the desired "soft landing."

Higher rates reduced the demand for interest-sensitive products such as housing and autos, while capital spending and exports sustained overall business output and employment. Inflation, after running at a heady pace in the opening months of the year due to higher energy and agricultural prices, seems under control.

Behind this soft landing lies a transition in the economy as well. Consumer spending weakened in 1989 while the manufacturing sector remained relatively strong. But slower overall demand is now taking its toll on capital spending plans, and the higher dollar will adversely impact net exports. In short, the economy will continue to post sub-par gains through 1990, although consumer spending will be on the rise while capital spending softens.

National Economy Changes

For the discount store industry, these changes in the national economy will increase overall demand somewhat in 1990 over the projected 1989 pace, but not dramatically. Regional variations will again shift, this time away from the capital producing areas, towards the South and Mountain states.

Through the first half of 1989, the economy has slowed from its rapid gains in the near past. After increasing 3.7 percent in 1987 and 4.4 percent in 1988, real GNP during the first half of 1989 showed an average increase of only 3.3 percent from the first half of a year ago. Gains will be even lower in the second half of 1989, reducing the annual rise for 1989 to only 2.7 percent.

Capital spending will be a major factor in sustaining the advance in the economy during the second half of 1989. The latest government survey of business investment plans for 1989 shows an increase in spending of 7.7 percent above the inflation rate. Investment has been improving for the last few years. After declining 3.3 percent in 1986, it increased 3.9 percent in 1987 and 8.4 percent in 1988.

Next year is likely to be another year of slow growth, but without a business correction. Capital spending on equipment won't advance as rapidly as in 1988 or 1989, and exports will be pressured by the current rise in the dollar's value. The softness in non-residential construction and multi-unit residential housing should persist. Defense spending will come under increased scrutiny as a means to hold the budget deficit in check.

The big question for 1990 is the direction of interest rates. Our current outlook calls for rates to be slightly higher than they are now, a negative factor for housing and other big ticket consumer purchases. Should rates decline, the economy and discount store sales will be stronger.

The new source of strength in the economy in 1990 should be the consumer. Spending has been held somewhat in check in 1989, as consumers put their finances in order. Consumers' savings rates have risen to 5.5 percent in the first half of 1989, up from a 4.2 percent average during 1988 and 3.2 percent in 1987.

Inflation will remain the largest single determinant of the direction of the economy through 1990. Fears of higher prices will force the Federal Reserve Board to tighten credit, increasing rates, as well as lowering the overall economy.

Consumer Price Index Rises

Inflation rose rapidly in the first five months of this year, pushed mainly by higher energy and agricultural prices. The consumer price index was rising at a 6.8 percent annual rate in this period, the producer price index by 8.9 percent.

Recently, price increases have come down, the producer price index was down for the latest three consecutive months. Neither pattern tells the entire story, however.

The volatile food and energy components accelerated the rate of inflation in the first half while braking it sharply in recent months. While in the last three months the total producer price index declined, it would have risen sharply in two of these months without the declines in the food and energy components.

The major force for inflation in the economy is not food or energy, but labor. Shortages exist in most major markets, increasing wage demands.

At the same time, fringe benefits such as health care are on the rise. While the usual inflation indexes have whip-sawed this year, the trend in overall labor costs, including benefits, has remained about 5.4 percent. This is a better measure of the underlying inflation forces, not the month-to-month changes in the total producer price index.

Pressure on Labor Demands

Additional pressure will be placed on labor demands through 1990 because labor has not been able to get wage increases that exceed inflation. Real wages, over the last three months, have averaged a decline of 1.5 percent from a year ago. It will require a continuation of the current slow growth in GNP to reduce the pressure in labor markets to allow the underlying rate of inflation to come down.

While the consumer price index rose 4.2 percent in 1988, it should be up 5 percent in 1989 and 5.3 percent in 1990.