Where are embattled British consumers spending their money?

When Next’s chief executive warned in March that soaring inflation and stagnant sales would result in a “challenging” year ahead, City took notice.

Shares of the top-tier leader fell nearly 8 percent following the earnings warning and comments by Lord Simon Wolfson, who is honored as the longest-serving boss of the FTSE 100.

But the three-month picture looks very different: in June Lord Wolfson improved the retailer’s annual profit forecast, arguing that the combination of April’s pay hikes and warmer weather had encouraged shoppers to spend more on their summer clothes. The owner of Primark, one of Europe’s largest clothing retailers, followed suit with an increase in his own profits driven by higher prices and strong clothing demand.

The more upbeat mood of Britain’s two largest clothing chains has confounded policy makers seeking to tame rising inflation by raising interest rates.

Despite soaring mortgage costs, bigger energy costs and higher food prices, UK retail sales unexpectedly increased in May driven by spending on summer clothing and outdoor goods, according to data published by the Office for National Statistics. Consumer confidence in the UK improved for the fifth straight month last month despite “fierce economic headwinds”, according to research group GfK.

But even though the overall picture is of people still overindulging themselves and charging higher fees for things that don’t matter, there are winners and losers in it. Analysts also ask how resilient household spending really is amid sky-high inflation and millions of homeowners finding themselves squeezed by higher mortgage payments.

“Yes, retail sales are holding up, but most importantly, they’re driven by inflation, and actually, people are cutting back and they’re buying less,” said Richard Lim, chief executive of Retail Economics.

He points to the wedge between the volume of a product sold and how much it costs to buy it — consumers pay more and get less in return, he explains.

Nothing is more flashy than the casual dining sector. Like-for-like sales at UK restaurants in May rose 2.7 per cent, compared with a year ago, according to data from CGA by NielsenIQ. Pub sales were 8.8 percent ahead of last year. But high inflation meant sales volumes were both below May 2022.

Few restaurant bosses are more aware of the economic challenges than Dean Challenger, Prezzo’s chief executive. Earlier this year, the casual Italian restaurant chain cut a third of its site, let go of about 800 staff, and entered a restructuring process just to stay afloat.

Challenger says customers are making careful choices about when to exit. Demand during peak trading periods, such as the summer and winter holidays, remains strong, but at the cost of making the quieter periods less productive. “People are more careful during quiet times, so they can enjoy busy times and school holidays,” said Challenger.

Two-fifths of consumers surveyed by CGA said they went out to eat and drink at least once a week in April – that number was unchanged from March, but fell by two percentage points in October last year.

Martin Williams, chief executive of Rare Restaurants which owns the steak chain Gaucho, is a mixture of optimism and caution. He was surprised by the level of demand at the 200-seat outpost Gaucho in London’s Covent Garden district, with sales in just two weeks already ahead of six months projected.

“This is beyond what we could have imagined,” he said, but added: “There is no doubt this is a difficult time.” He predicts the second half of the year will be more challenging. “Each rate hike reduces disposable income, and that means less money to spend at restaurants.”

Like its rivals, Williams continues to have to manage high input costs – all the while wondering whether strong consumer demand can stay afloat, as rising mortgage rates further eat away at diner incomes. He has added a more affordable £30 three-course lunch option to the menu as a result.

Williams said its 2022 sales were up about 25 percent on its 2019 pre-pandemic benchmarks, but so far this year has been flat compared to last year.

There is evidence that upscale restaurants are better protected. Profit margins at high-end business chain Ottolenghi fell just one percentage point year-over-year despite high inflation—and spending per head was up compared to last year, while dishes ordered per head were flat.

“Probably most of our customers are in clusters where if your mortgage payment goes up, you’re not happy but that doesn’t mean you have to cut other expenses,” said Emilio Foa, chief executive. Mid-market restaurant chains are “suffering the most”, he added.

Mid-market retailers are also “struggling” said Lim at Retail Economics. Several well-known brands such as Hunter and Joules have fallen into administration over the past year. “They don’t have a strong enough proposition. They still have to fight at all costs and it’s being squeezed [profit] margins are really hitting the middle of the market where there is much weaker consumer demand,” he said.

While Next and Primark are both major chains, they have long been outliers in the troubled and “unreflective” retail landscape [wider] market performance,” he added.

Discounter B&M, which sells items ranging from garden tools to frozen meals, is benefiting from consumers having a hard time finding bargains. “Clearly we see trade hanging in our hands,” said chief executive Alex Russo. Like-for-like sales in the three months to June 24 rose 9.2 per cent in the UK.

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But retailers selling more expensive items, such as furniture and home appliances, have suffered. Bike and auto parts seller Halfords saw profits fall last year as the boom experienced during the Covid-19 pandemic ended. Chief financial officer Jo Hartley told investors in April that it had “never been more difficult to predict customer behavior or cost inflation”.

Customers are also relying more on credit to buy technology, white goods retailer Currys said in May. “We are still seeing consumers being very careful with their spending,” said CEO Alex Baldock.

One of the clear winners among consumer spending is travel. Airlines are in the middle of a busy summer, with travelers undeterred by the weak economic backdrop and high ticket prices, which were up more than 30 percent year-on-year across Europe in May.

UK airline executives believe consumers are prioritizing spending on holidays over other discretionary expenses, especially after years of travel restrictions due to the pandemic. British Airways owner IAG raised its annual profit forecast last month, as did low-cost carrier easyJet in April.

“Certainly, ‘revenge’ travel underpinned the recovery this year, but without the restrictions and health concerns, people seem keen to resume flying more permanently, especially for recreational purposes and for family visits,” said Rico Luman, senior economist at ING.

But the trend is for shorter trips: easyJet boss Johan Lundgren noted in a recent earnings report that people have booked shorter vacations this summer, with the average trip lasting seven days, down from nine last year.

However, there are early signs of a slowdown, with ticket sales data showing a progressive decline in demand since early April, according to Olivier Ponti, an executive at flight data company ForwardKeys.

Paul Charles, chief executive of travel consultancy PC Agency, said despite a “bumper” summer for travel operators, he expected that demand “would not continue at the same pace beyond the summer”.

“Higher mortgage rates and prices across the economy will cause some people to tighten their belts, so I expect the September to December period to see lower demand,” said Charles. “But in the higher end and luxury markets, the boom will continue.”