Shares in Next plunged over seven per cent on the FTSE 100 after the retailer reported a rise in sales at the lower end of previous guidance and warned of tough times ahead as the government prepares to raise taxes and cut spending.

In May of this year Next said it expected total retail sales to rise between 0.5 and 3.5 per cent in the half year ended 31 July 2010. Today however the group said that total retail sales increased by just 1.3 per cent in the period.

Sales at Next Directory however were better than predicted, rising 7.8 per cent, well above the guidance of 2.0 to 5.0 per cent given by the company in May.

Next said that the rise in VAT brought in at the start of the year had led to a fall in reported sales of 1.5 per cent, however the group said that the effect of this on profits had been offset by gains in bought-in gross margin.

The group said that its End of Season Sale is progressing well and is in line with its forecast clearance rates.

Capital investment this year is expected to reach £135 million, the company said, and will take precedence over paying dividends. Despite this Next said it was aiming to increase its annual dividend by 10 per cent this year.

Pre-tax profit for the full year is also expected to rise between six and 11 per cent to between £535 million and £560 million.

In an outlook statement Next said, "There has been a noticeable cooling in retail demand in recent months, the mood amongst consumers is best characterised as cautious. We believe that consumer spending will be more restrained in the second half than in the first, as spending cuts and tax rises begin to take effect. We are budgeting for total Retail sales to be in the range -1.5% to +1.5% (implying like for like of -1.5% to -4.5%) for the second half, this is VAT exclusive and does not include direct sales. We expect that new space will add +3% to sales. This might sound overly cautious, however, it is important to remember that our reported sales will continue to be 1.5% less than actual sales to consumers as a result of this year's VAT rise and that comparisons become increasingly difficult against last winter's strong performance.

"On a more optimistic note we believe the ongoing trend of increased online shopping combined with an improved service offer will allow Directory sales to continue growing in the range +4% to +8%. This means we are expecting total Next Brand sales in the second half to be in the range 0% to +3% up on last year."

However the retailer warned of tougher times ahead, saying, "The combination of higher cotton prices, capacity tightening and a lower dollar costing rate mean that we will experience input cost price inflation in the first half of 2011. We aim to mitigate some of the effects of this with the development of new sources of supply and more rigorous negotiation. However, the combination of increasing cost prices and the January 2011 VAT rise mean that clothing retail prices are likely to rise in Spring 2011. We have yet to purchase the majority of our spring summer ranges, but we estimate that selling prices may rise between 5% and 8%."

By 13:55 shares in Next were down 7.28 per cent on the FTSE 100 to 2,039.00 pence per share.

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