Deflation poses threat to big-ticket retailers

U.S. retailers' efforts to rebound from the recession could hit a dead end. Deflation risks have risen in the past few weeks, spelling particular gloom for sellers of big-ticket items.

While pockets of inflation may be cropping up in food and low-priced items, deflation could be just as much of a concern for sellers of appliances and vehicles, which are often the first items to be struck off shopping lists in a difficult economy.

Grim data on economic growth, consumer spending and housing, along with stubbornly high unemployment, have fanned fears of a deflationary environment where weak consumer demand forces a steady fall in prices of goods.

Moody's Analytics chief economist Mark Zandi sees a one in six chance of outright deflation in the U.S. economy, while some others said the odds could be as high as 50 percent.

"No industry suffers more from deflation than retailers," Zandi said, since they already operate on thin margins.

The timing of a bout of deflation could not be worse.

After offering mega-discounts to boost spending in the trough of the recession, retailers are struggling to retrain Americans to buy goods at full price.

If consumers postpone purchases, inventory builds up, forcing retailers to drop prices, said Kronos Chief Economist Robert Yerex.

Last month, appliance maker Whirlpool Corp (WHR.N) refrained from raising its shipment forecasts, citing slowing growth in demand.

Appliances contribute significantly to sales at retail goliaths like Home Depot (HD.N), Lowe's (LOW.N), Sears Holdings (SHLD.O) and Best Buy (BBY.N). Sears typically does not comment on economic trends, spokesman Larry Costello said, and the other companies declined to comment.

Already in June and July, U.S. retailers relied heavily on discounting to win shoppers ahead of the key back-to-school season.

"The consumer is not cracking," said David Berman of Durban Capital, a New York hedge fund that specializes in retail stocks. "The consumer just needs a bigger bargain than usual."

Any further weakness in demand would curb retailers' ability to pass on higher costs to shoppers.

A study on Tuesday showed that Wal-Mart Stores (WMT.N) backed away from steep grocery discounts in July, playing into the wider economic debate about whether high unemployment will prod the United States into a deflationary environment, or whether rising material and labor costs will force retailers to push prices higher.

'The Big Squeeze'

Falling pricing power coupled with rising costs in China and weakness in the value of dollar against the Chinese yuan could put retailers in what Zandi called "the big squeeze."

"The global economy is headed for a wrenching adjustment," University of Maryland professor Peter Morici said. A former director of the Office of Economics at the U.S. International Trade Commission, Morici pegged chances of deflation in the U.S. economy at 50 percent.

With the odds of a significant acceleration in inflation in the next 12 months seeming negligible, consumers who were already holding tight to their cash might keep holding out, expecting prices to fall further.

"Just when it looks like buyers were starting to come back, now they have another reason to wait," Yerex said.

Falling energy costs pushed U.S. consumer prices down for a third straight month in June while consumer sentiment dropped to a near one-year low in July.

In Fed We Trust

While investors are looking to gain from the weakness, top officials are voicing their concern.

The Federal Reserve took a small but significant step on Tuesday to counter a weakening U.S. economic recovery, saying it would use cash from maturing mortgage bonds it holds to buy more government debt.

The move came just days after Federal Reserve Bank of St. Louis President James Bullard warned that the United States "is closer to a Japanese-style (deflation) outcome today than at any time in recent history."

If budget-conscious Americans continue to put off purchases in hopes of bigger discounts and the economy weakens in the second half as many economists expect, fears of a full-fledged deflationary environment could come true in six months to a year, some warned.

"Whether we think prices are going to go up or down actually has some impact on whether they do go up or down," Yerex said. "It is especially true in deflation."

[Source: By Dhanya Skariachan, Reuters, New York, 11Aug10]

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