The economic environment for S&P/ASX 200 Index (ASX: XJO) retail shares is uncertain amid high cost of living, high interest rates and higher costs for retailers.
The Reserve Bank of Australia (RBA) is deliberately trying to take demand out of the economy with a high cash rate.
However, collectively, households kept spending at stores during (the first half of) FY24. With the 2025 financial year almost upon us, it's worth considering whether there are opportunities in the sector.
The ASX 200 has many retailers within the index, including Wesfarmers Ltd (ASX: WES), Woolworths Group Ltd (ASX: WOW), Coles Group Ltd (ASX: COL), JB Hi-Fi Ltd (ASX: JBH), Harvey Norman Holdings Limited (ASX: HVN), Premier Investments Limited (ASX: PMV), Metcash Ltd (ASX: MTS), Lovisa Holdings Ltd (ASX: LOV) and Super Retail Group Ltd (ASX: SUL).
Strong inflation to keep rates higher for longer
Australia's CPI inflation measure accelerated in May at a rate that was more than expected. As reported by my colleague Bernd Struben, Australian inflation was forecast to have increased 3.8% on an annualised basis, up from 3.6% in April. It was actually a 4% increase in the 12 months to May 2024.
What could this mean for the RBA's interest rate though? According to reporting by the Australian Financial Review, VanEck head of investments, Russel Chesler, said rate cuts have been delayed, and it has increased the possibility of an increase:
We weren't expecting the RBA to cut rates until the second half of 2025, but the hotter-than-expected CPI print today indicates this could be even further away.
Forget 'higher for longer' – we may end up being the 'highest for the longest'.
Interest rates remaining higher could mean some household spending remains restrained during FY25. This could be troubling for ASX 200 retail shares if it means lower earnings. Rising costs can also be a headwind for earnings if wages and rent keep rising at a painful rate.
A couple of weeks ago, in the RBA's latest interest rate decision announcement, the central bank said:
Inflation is easing but has been doing so more slowly than previously expected and it remains high. The Board expects that it will be some time yet before inflation is sustainably in the target range. While recent data have been mixed, they have reinforced the need to remain vigilant to upside risks to inflation.
The path of interest rates that will best ensure that inflation returns to target in a reasonable timeframe remains uncertain and the Board is not ruling anything in or out. The Board will rely upon the data and the evolving assessment of risks. In doing so, it will continue to pay close attention to developments in the global economy, trends in domestic demand, and the outlook for inflation and the labour market. The Board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that outcome.
ASX 200 retail shares are not fully exposed to Australian discretionary spending
It's important to note that the ASX 200 retail shares are among the biggest and strongest retailers in the country. They have the balance sheets to absorb difficult operating conditions, they have the scale to offer customers the best prices, and they have the marketing budgets to stay in front of customers.
Discretionary spending may be challenging for some households in FY25, but there are plenty of mitigating factors as to why these stocks could still do well even if it falls.
Coles, Woolworths and Metcash all sell food, which households need to keep buying. Indeed, they could see increased demand if people reduce eating out and Australia's population keeps increasing.
Premier Investments, Harvey Norman and Lovisa have global earnings with expanding store networks, so they're reducing their exposure in percentage terms to the Australian consumer.
JB Hi-Fi's product demand may be more defensive than it used to be because it sells appliances and smartphones, which we all need in our homes.
Wesfarmers' Bunnings and Kmart businesses are reportedly capturing market share during this period as more customers look for value.
FY25 could be a fascinating year for ASX 200 retail shares. Earnings could be more resilient than the bears expect, even if the share prices experience some volatility.
