(Bloomberg) -- UK retail sales rose unexpectedly last month after post-Christmas discounting brought people into stores.

The volume of goods sold in stores and online rose 0.5% in January after a 1.2% decline in December, the Office for National Statistics said Friday. Economists had expected a drop of 0.3%.

The figures suggest consumers are weathering a cost-of-living squeeze better than forecasters think. That may add to concerns at the Bank of England about inflation, which is running at the fastest rates in four decades.

“There is clearly still life in the consumer,” said Neil Birrell, chief investment officer at Premier Miton Investors. “Those thinking that the Bank of England might start moderating policy in the short term will be disappointed. Overall, the economic data is ambiguous, making the short and medium-term outlook really very uncertain.”

Money markets pushed up the possibility of further BOE rate rises, pricing in the key rate rising a half percentage point to 4.52% by September. That’s up 6 basis points from Thursday. 

What Bloomberg Economics Says ... 

“An unexpected bounce in retail sales at the start of the year is unlikely to prevent Britain from falling into a recession. Instead, consumer spending is set to remain under pressure amid the biggest income squeeze in a generation.”

—Niraj Shah, Bloomberg Economics. Click for the REACT.

The ONS said discounting helped boost sales, although those that sold food and clothing suffered. Fuel sales rose as prices at the pump fell along with the cost of crude oil.

“After December’s steep fall, retail sales picked up slightly in January, although the general trend remains one of decline,” said Darren Morgan, director of economic statistics at the ONS. “Discounting helped boost sales for online retailers as well as jewelers, cosmetic stores and carpet and furnishing shops.”

While sales in clothing stores were down 2.9% month-on-month, household goods shops saw volumes climb 0.8%. Shops in the ONS’s catch-all “other stores” category saw their sales jump 3.6%.

The figures will help the BOE weigh how much further it will need to raise borrowing costs to head off an inflationary spiral. Money markets indicate the key rate, now the highest since 2008, may rise at as much as a half point beyond the current 4% by the end of summer.

Retail sales remain 1.4% below their pre-pandemic level. But the value of sales rose 14% over the same period, indicating that consumers are paying more to buy a smaller amount of goods because of inflation.

Separate reports out this week showed that wages adjusted for inflation are falling and double-digit inflation persisted for a fifth consecutive month. BOE Chief Economist Huw Pill on Thursday said policy makers must remain vigilant against inflation but hinted the pace of rate hikes may slow.

“As the labor market tightens, there’s a risk that retailers will be drawn into a race to raise employees’ salaries,” said Aled Patchett, head of retail and consumer goods at Lloyds Bank. “This could fuel inflation, which although likely to temper towards the second half of the year, will still remain uncomfortably high.”

The fall in sales in December was more than the 1% previously estimated, but is unlikely to have pushed the economy into recession. The ONS said sales knocked 0.05 percentage point off GDP in the fourth quarter, unrevised from its initial estimate.

Lynda Petherick, head of retail at Accenture, said retailers would be “relieved to see trading move in the right direction.” But she added, “the road ahead for businesses continues to be a rocky one. Data out this week shows prices are continuing to climb, albeit at a slower rate, so consumers are still likely to be mindful of cutting back.”

Post-Pandemic Shift

Last month’s readings reflect a shift toward more normal trends after the pandemic. Alcohol sales plunged from a year ago as people returned to restaurants and bars.

The proportion of online sales fell to 25% in January 2023 from 25.7% in December 2022, signaling that more consumers were going back to Britain’s struggling bricks-and-mortar stores. But the proportion of online sales is still far higher than the pre-pandemic level of 19.8% in February 2020.

“The one bright spot for high streets is the continued fall in penetration of online shopping,” said Lisa Hooker, industry leader for consumer markets at PwC. “This suggests that the pandemic shift to e-commerce did not create a sustained step up in online shopping.”

Retailers remain gloomy about the outlook and reported disappointing takings in recent weeks as households reined in spending after a splurge over Christmas. 

Even supermarkets are feeling the pain. Shoppers bought less fresh produce and meat and poultry while sales of frozen goods grew, according to a report by NielsenIQ earlier this month.

Unilever Plc, the consumer-goods giant that makes everything from Dove soap to Ben & Jerry’s ice cream, warned last week that shoppers are balking at higher prices, which will cut its growth this year. The premium supermarket chain Waitrose is cutting prices at record rates to keep its customers from flocking to discount stores like Aldi and Lidl.

“We’re seeing polarization between the essentials and non-essentials,” Kris Hamer, director of insights at the British Retail Consortium Director, said on Bloomberg Radio. The key area where growth is still continuing is largely driven by inflation. In all the other categories, there’s either stagnant growth or negative growth.”

Paul Dales, chief UK economist at Capital Economics, pointed out that a year ago consumers were kept out of stores by a resurgence of the omicron variant of Covid-19 and that the impact of higher borrowing costs has yet to fully feed through to the economy.

“The full drag on activity from higher interest rates has yet to be felt,” Dales said. “As such, it is too soon to conclude that the retail sector is coming out of its funk and that the economy won’t yet fall into a recession.”

--With assistance from Andrew Atkinson, Joel Rinneby, Harumi Ichikura, Katie Linsell, James Hirai, Caroline Hepker and Lizzy Burden.

(Updates with comment and market reaction from fourth paragraph.)

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