(Fri 05/09/14 18:51:00)

LONDON (Sept 05): With the Bank of England preparing the ground for an increase in interest rates, investors are questioning the durability of a long boom in cheap credit which has driven consumer-focused British stocks to record highs.

Although the timing and scale of any rate rise remains uncertain, some investors are pulling back from the UK consumer goods sector on perceptions that credit-fuelled demand will be squeezed in the short term.

Data shows that shares in consumer stocks have risen in tandem with borrowing levels. The MSCI UK consumer discretionary index hit a record high in July, at the same time as consumer credit rose to a four-year high.

UK consumer credit vs retail stocks: http://link.reuters.com/zyk72w

A pull-back since July, even accounting for other factors hitting markets such geopolitical tensions, points to an increasingly bearish backdrop for sectors like travel & leisure, autos and some retail firms.

The consumer discretionary index has fallen more than 4 percent from its July peak, while the blue-chip FTSE 100 index has flatlined.

"The impact of a UK rate hike would indeed be negative on consumer-facing sectors, especially after a good run and stretched absolute valuation metrics," said Jeremy Batstone-Carr, head of private client research at Charles Stanley.

"They could suffer disproportionately."

The latest Reuters poll shows that the Bank of England will raise its key Bank Rate by 25 basis points in the first quarter of 2015 from a record low of 0.5 percent.

According to a recent study by independent firm Verum Financial Research, every 0.5 percent hike in the UK base rate would cut 4.8 billion pounds ($7.96 billion) from household spending, and a 3 percent rise would wipe off about 30 billion pounds due to higher debt interest payments.

It estimates that the total amount of credit owed by UK households has more than quadrupled to 1,437 billion pounds in 2013 from just 347 billion pounds in 1990. Significantly higher debt levels, which have grown from 90 percent of household disposable income in 1990 to 130 percent in 2013, mean that households are much more vulnerable to marginal rate hikes.

"Household debt levels in the United Kingdom are much higher due to significantly more home ownership, against countries like Germany and the United States," said Adrian Fitzpatrick, head of investment dealing at Aegon Asset management.

"Luxury-goods companies such as Burberry may suffer more than others and some cheaper alternatives could benefit as people switch from the high end to the low end. You may find that companies specialising in DIY (do-it-yourself), such as Homebase, could benefit in this kind of environment."

Burberry shares have fallen about 5 percent since June, while Home Retail Group, which owns home improvements chain Homebase, has gained about 1 percent during the same period.

Variable pains

Analysts said general retailers are likely to suffer, while discount retailers are expected to benefit. Travel and leisure stocks would be among the worst hit as higher rates would lower households' disposable income especially due to higher mortgage payouts, they added.

Historically, some consumer-facing stocks have generally underperformed in a rising rate environment. Shares in retailer Next fell almost 30 percent from May to July 2007 when rates rose 5.50 percent to 5.75 percent, while holiday operator Thomas Cook and housebuilder Persimmon dropped about 20 percent during the period.

"At the moment, I am avoiding UK retail and consumer related stocks because the economic catalyst remains quite far away and I don't see wage growth picking up anytime soon," Edmund Shing, global equity fund manager at BCS Asset Management, said.

A rate hike will directly hit homeowners, who have seen low mortgage payments due to low interest rates for several years.

The Thomson Reuters UK housebuilding index is down about 9 percent since late February after spiking 67 percent in the previous 12 months on low rates, government incentives for home buyers and a house price boom. Firms like Barratt Developments, Persimmon and Bovis Homes have fallen 6 to 15 percent during the same period.

"The main concern is that if you start raising rates, mortgages will become unaffordable for many at a time when wages are not rising in line with inflation," Oliver Wallin, investment director at Octopus Investments, said.

"Consumers are likely to feel the pressure."