Surprise! British retail sales surge in December

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British retail sales came in way above expectations in December, official data showed on Friday, with strong growth at smaller stores resulting in the largest annual rise since 2004.

Retail sales volumes rose by 2.6 percent on the month, according to figures released by the U.K.'s Office for National Statistics (ONS) — the largest increase since February 2010. Economists had expected a 0.4 percent monthly rise, following an increase of 0.3 percent in November.

On the year, meanwhile, retail sales expanded by 5.3 percent -- significantly higher than the 2.6 percent hike forecast by economists.

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Small retailers fared much better than larger stores, with sales 8.1 percent higher at small shops in December compared with the same month in 2012. By contrast, sales rose by 2.6 percent at large retailers.

Howard Archer, chief U.K. and European economist at IHS Global Insight, said the data indicated that consumers had postponed their spending to cash in on last-minute deals.

"The surge in retail sales in December following a muted overall performance in November and October indicates that consumers left much of their Christmas spending late in the hope of getting better late deals from retailers," he said in a note.

"It also implies that spending was strong at the start of the clearance sales as squeezed consumers looked to take advantage of genuine bargains."

Christmas shoppers fill the pavements of Oxford Street
Leon Neal | AFP | Getty Images

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The data will further boost expectations that Britain will post strong gross domestic product (GDP) growth in the fourth quarter of last year, amid increasing hopes of a sustained economic recovery in the country. The data is due to be released on January 27.

"December's strong retail sales performance provides a major boost to hopes that GDP growth in the fourth quarter of 2013 remained up around the 0.8 percent quarter-on-quarter rate achieved in both the third and second quarters," Archer added.

The U.K.'s third-quarter GDP expansion of 0.8 percent marked its fastest growth since 2010.

Meanwhile, unemployment in Britain fell faster than expected in the three months to October. The headline rate fell to 7.4 percent – its lowest level in four and a half years – and employment rose by 250,000 to a new record high of 30.086 million.

Sales surprise

But despite this improving economic picture, Friday's retail sales data were particularly surprising given the number of large U.K. retailers that had reported weak sales for the festive trading period, as heavy discounting and subdued consumer spending took their toll.

EY ITEM Club's Senior Economic Adviser Andrew Goodwin said he was "extremely skeptical" about the retail figures.

"This is a massive upside surprise which really stretches credibility to the maximum," he said in a note.

"If (the figures) are not revised then the chances are there will be a large fall in January. The numbers simply do not tally with what we have been hearing from companies over the last week. In particular, department stores and food retailers who, with few exceptions, have reported weak trading during the festive period."

Clothes and food chain Marks & Spencer, for instance, reported its 10th consecutive quarter of falling clothing sales, although its food business, which represents over half of group sales, performed better than analysts expected.

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Meanwhile Tesco, the world's third-largest supermarket group by sales, said like-for-like sales excluding fuel in the U.K. fell 2.4 percent in the six weeks to January 4. And at WM Morrison, like-for-like sales excluding fuel dropped 5.6 percent in the six weeks to January 5.

It also contrasted with figures released by the British Retail Consortium (BRC) last week, which said December retail sales in the U.K. were up just 1.8 percent from December 2012. The BRC's report is largely based on sales in larger stores.

Earlier this week, financial research firm Markit revealed that retail stocks in the U.K. had seen a spike in short-selling since the start of the year, as investors bet against some of the biggest names on main street. Short-selling is an investment tactic where a speculator borrows a financial instrument, such as a stock, and sells it in the hope of buying it back later at a lower price, thereby making a profit.

By CNBC's Katrina Bishop. Follow her on Twitter @KatrinaBishop and Google