As budget tax increases and benefits cuts take effect, retail spending is unlikely to improve soon

CONSUMERS WILL be central in determining whether this economy crawls out of the slump in which it remains mired. Their spending on goods and services not only accounts for half of gross domestic product (GDP), it has a more direct and immediate knock-on impact on the rest of the economy than, say, exports, which also account for a large chunk of the economy.

What are the prospects that tills will ring louder over the rest of the year?

The most recent indicators give cause for concern. Yesterday’s retail sales figures for December, which should be treated with some caution owing to the severity of weather conditions during that month, registered another month on month fall by all main measures.

But if snow and ice kept shoppers at home last month, weather cannot be blamed for a downward trend that stretches all the way back to springtime. Seasonally adjusted “core” retail sales, which exclude the volatile motor trade, have been trending downwards since April (see chart 1), indicative of the weak position of consumers and the domestic economy more widely.

With declines of 5-7 per cent between April and December, the weakening of core sales since the spring has been considerable and is certainly not consistent with economic recovery.

Total retail sales, which include autos, have also displayed a similar pattern since last April, although the decline has been less marked. Much of the reason for this is likely to be the result of the Government’s wasteful car scrappage scheme. The scheme amounts to a subsidy to foreign auto-makers, one which Wednesday’s import figures suggest they are fully taking advantage of. Despite the weakness in home demand, imports of consumer goods (which include most auto imports) trended up over the course of the year to October (see chart 2). Car purchase subsidies have the effect of crowding out domestic producers of goods, as relative price changes caused by the subsidy give consumers an incentive to shift their buying patterns towards made-abroad cars.

Trends in retail sales in Ireland were out of line with patterns in consumer behaviour across the euro area in 2010. For the bloc as a whole, retail sales volumes grew marginally over the course of the year from April. Harmonised figures show they shrank in Ireland. Only two of the other 17 member economies of the single currency – including, unsurprisingly, our companion in bailout ignominy, Greece – recorded bigger falls in sales volumes over the same period according to Eurostat, the EU’s statistics arm.

If anything, however, the only surprise is that the Irish retail sector did not suffer even more in 2010, particularly in the second half of the year when the banking crisis ran out of control, raising fears that the entire system would collapse, and the international community decided on pre-emptive intervention.

Although the indicator of consumer sentiment put together by the Economic and Social Research Institute (ESRI) and KBC Bank has not been strongly correlated with any hard measure of consumer activity during the recession, its collapse in the second half of the year (see chart 3) chimes with so much of the anecdotal evidence one hears from the guy in the street and from businessfolk in the retail sector. By December, the 15-year-old ESRI/KBC index was back to the all-time lows it hit when the economy was in freefall in late 2008 and early 2009.

Being back on the bottom is not a good place to be. Getting up won’t be easy because the downward pressure keeping consumers on the floor in 2011 is so powerful.

The impact of tax increases and benefits cuts introduced in the budget, which will shrink pay packets and welfare cheques in January for the first time, will almost certainly ensure that the decline in retail spending continues into the first months of 2011 at least.

With weakness in the jobs market and downward pressure on pay rates, aggregate incomes don’t look like bouncing upwards soon.

People are also likely to continue to save a large percentage of whatever income they earn for a number of reasons. One is the continued decline in house prices. All the property price indices released over the course of the first month of the year show that stabilisation of the market is still some way off.

Continued falls in the value of what is the biggest asset most households possess can only make folk feel poorer, another factor in depressing spending – this is called a negative wealth effect in the economics jargon.

If yesterday’s retail figures do not augur well for the future, they also increase the risk that the economy lurched back into recession in the final quarter of the year.

With total retail sales accounting for about 25 per cent of GDP, the 0.5 per cent quarter on quarter contraction in the October-December period will dampen overall growth. So too could the erstwhile engine of growth – exports.

Wednesday’s trade figures show that in the first two months of the final quarter, goods exports declined on the previous quarter. Although the fall was small, it is in stark contrast to the strong growth earlier in the year. And it was that growth that dragged the economy back to expansionary territory in the third quarter.

The GDP figures for the last quarter of 2010 won’t be released until the second half of March. They may not bring the kind of news a new government, whose ministers have hardly warmed their cabinet seats, would wish for.