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Monday, September 1, 2008

Have German Retail Sales Now Passed Their "Peak"?

Sharp Drop In June Sales

Retail sales in Germany, Europe's largest economy, fell a second month in July as rising prices and a slowing economy acted as a brake on household spending.

Price and seasonally adjusted retail sales were down by 1.5 percent in July over June, when they fell by 1.4 percent, according to the latest data from the Federal Statistics Office. On a year on year basis there was no change over July 2007.

Now the ongoing lacklustre performance of German domestic consumption during what has been an unprecedented economic expansion in recent terms is causing a lot of heart-searching at the moment, but what many observers seem to fail to be taking note of is that German retail sales have been dropping steadily for time now, at least as measured by the seasonally adjusted constant price index.

More importantly - as will be argued in this (and other accompanying) posts - there are serious theoretical grounds (in the context of Germany's ageing population problem) for postulating that Germany's retail sales may NEVER rebound again on more than a conjunctural basis, that is we may see local "peaks" and "troughs" but the secular decline may now not reverse. This is a point which most of consensus analysts who look to a cyclically driven "rebound" in domestic consumption appear to fail to take into account.

But before going further with this point, let's take a look at some more data.

Slight Improvement In The Rate Of Contraction In The August PMI

The latest Bloomberg eurozone Purchasing Managers' Index, based on a mid-month survey of economic conditions in the euro area retail sector, pointed to a continuing contraction in retail sales across the eurozone for the third consecutive month in August. While the PMI rose to a three-month high of 47.7 it remains below the crucial 50.0 zero growth mark.

There was some, however, some variance in retail sales trends across the three largest euro area economies. Italian sales continued to fall, extending the current period of month on month consecutive declines to a year-and-a-half. However we did hit a nine month "high" with sales contracting at the slowest pace since last November, rising to 44.8 (or minus 5.2) from 38.2 (or minus 11.8). Thus August revealed a significant eeasing in the rate of contraction (a finding which is completely in harmony with the rather better consumer confidence index reading for August. Indeed the fall in Italian retail sales in August was not as strong as the one in Germany, where the rate of decline - 44.1 - accelerated to its strongest pace so far this year.

So things in Italy are bad, and they are getting worse, but they are now getting worse more slowly than they were. The fact that in August oil prices were significantly down from the July peak obviously has something to do with this situation.

The August PMI data also revealed a rather higher level of pessimism amongst retailers with regard to September sales, with the index for the sales outlook registering 48.0, down from 49.5. The data revealed some variance across countries, while French and Italian retailers expect sales to come in below target next month, which reflects underlying concerns that the economic downturn will continue, German retailers were more positive, forecasting a stronger than previously expected performance.

At the same time GfK AG's consumer sentiment reading slumped to its lowest level in five years. GfK AG's index for September, based on a survey of about 2,000 people, fell to 1.5, the lowest since June 2003, from a revised 1.9 in August, the Nuremberg-based market-research company said in a statement today.

"Peak" Retail Sales

German retail sales appear, according to the Federal Statistic Office annual index, to have "peaked" in 2006 (see chart below, where the 2008 value is my own estimate based on the first half performance, and the not unreasonable assumption that the second half - given the generally weaker economic outlook - will be no better than the first half.

Now there are complicating factors here, since there was the notorious 3% VAT hike in January 2007, which obviously did constitute quite a price shock, and will have affected the level of sale, so I may be a bit quick off the mark in calling this the ultimate "peak", but before I go into this a bit more, let's explore the background argument a little.

So the question we are faced with now, is whether or not we are faced with a "peak" retail sales phenomenon? The theoretical basis for this assumption is on reasonably solid ground, and there is evidence to show the phenomenon exists in other ageing economies (Germany, Hungary, possibly Japan). In the Italian case, I have constructed my own makeshift index, and the performance of this index since 2003 can be seen below. It seems Italian retail sales may have "peaked" in early 2003, and since that time the decline has been continuous, although sales did stabilise during 2005 and 2006 (I will come to this point later).

Germany's population is now in fact contracting. According to the Federal Statistics Office German population "peaked" in 2002, at 82,537,000, and since that point it has been declining steadily.

Germany's population is also ageing, and we know from basic life cycle theory (Modigliani) that saving and spending patterns change across the life cycle, with the propensity to borrow against future income in order to buy now declining significantly among the over 50s, and since it is increasing consumer credit that drives retail sales growth in the dyamic internal consumption economies, then it is highly likely that ageing will now act as a drag on sales growth in countries like Italy with very high median population ages (43, along with Italy and Japan). As we can see in the chart below (which comes from the US Census Bureau database), Germany's median population age has been rising steadily, and at a very rapid rate (over 1 year's increase in median population age for each calendar year, of course historically this type of rapid ageing is quite unprecedented), with the only real substantial unknowns between now and 2020 being life expectancy, which may accelerate more than anticipated (in which case the population ageing will be even more rapid), and immigration, which will slow ageing down a bit.

Peak Construction Activity?

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