From Nuts to Soup?

Were we nuts to have been optimistic on Europe because its performance had held up in the face of austerity measures implemented across the continent? Is German retailing suddenly become this weak and is it slipping into the soup? It's hard to see how German retail sales could suddenly turn so sour especially with other more topical surveys on the German retail sector and consumer not showing this sort of flop. What are we supposed to believe? What are policymakers supposed to believe? If the policymakers are German it's not an issue since they only look at inflation. But now there is an Euro-Area and so the question matters again.

Europe continues to be a hard place to sort out trends. On one hand there is a lot of fiscal austerity in train that makes us wary about being too optimistic on the outlook. On the other hand some of the indicators from the Zone have been firm-to-strong even in the face of the fiscal challenge. Germany in particular has been channeling growth by tapping foreign demand even as it has implemented fiscal austerity at home. Because austerity is at home and demand is overseas there has been some presumption that Germany might weather the fiscal drag better than most with its divide and conquer strategy.

Until now Germany appeared to be doing just that, posting solid growth rates and strong orders reports albeit with some monthly ups and downs. The German industrial sector even in the very recent EU Commission survey with data through October seemed quite upbeat. But now Germany's retail sector is taking it on the chin.

German retail sales plunged in September. Sales fell by 2.4% month to month a drop so severe it has pulled down all the growth rates for retail sales across various horizons in a very noticeable way (see chart). However, since this plunge came late in the quarter the average spending for the quarter will still see a rise in Q3 over Q2. But of course the outlook for retail sales in Q4 is poor as it will start in a significant hole compared to average spending in Q3. In September, at the end of Q3, spending already is 1.7 percentage points below the average level of spending for the third quarter. This sort of adverse start will make it tough for retail sales to show any gain in 2010-Q4.

The German economy is not driven by the consumer or by retail sales. But private consumption is still over half of German GDP. That explains how retailing can fall off so badly and still have the industrial sector performing relatively well, carrying the economy. Still, this retail weakness is a worry for the outlook; this sort of consumer weakness will eventually become a problem, even for export oriented Germany. Partly the reason for concern is that weaker growth is a risk across Europe and German exports may not be able to keep up their good performance. If that happens, Germany will not have a strong consumer to fall back on.

The retail sales drop in September was a surprise. An increase had been expected. Up through October the German retail sales metric had not been weak in the EU Commission survey. Indeed, in September the German retailing indicator rose to a plus-seven diffusion value from plus-four in August although it has settled back down to a plus-four in October. Still these readings hardly are compatible with the actual deplorable result recorded in September.

Surveys and indicators and retail sales results are all over the map across EMU; even for the same country within EMU the data trends are a mess. Europe seems to be showing its more uncertain side while the US is showing signs of greater certainty and greater growth. That is the analysis du jour. Time will tell if it has staying power. For now there is enough going wrong and raising eyebrows in Europe to warrant a skeptical position on the outlook there.