• Although September retail sales declined on the headline, the details in the report provided good news on the underlying strength in consumption.
  • The data suggest that personal spending has been tracking slightly above 3% in Q3. In Q4 consumption growth will take a hit due to the negative backdrop from the clunkers programme.
  • The outlook for consumption hinges on the strength of the labour market and its ability to support real income growth. We continue to expect a moderate spending recovery in 2010.

Details: Retail sales surprised on the upside and came in better than expected on most measures. That said the upside surprise was driven by a smaller-than-expected decline in auto sales, which was largely mirrored by a downward revision to the August auto sales. 
Importantly, the underlying trend in retail sales continues to improve. Core sales (ex. auto, building and gas) were up 0.5% m/m following an unrevised increase of 0.7% m/n in August. The three-month average run rate for core sales has now recovered to about zero percent, up from a trough of -8% AR. We look for further, but modest recovery in the coming months.   

Indeed this is good news and suggest that the improvement in consumption is not been driven solely by auto sales. Personal spending ex. car should now have recovered back to levels close to the peak in mid 2008.  

The report did not embed any revisions with significant importance for the national account consumer spending data. Generally, the numbers suggest that real personal spending fell by about 0.5% m/m in September (due to the decline in auto sales). We estimate the car sales have subtracted about 0.9pp from personal consumption in September, which implies that real private consumption ex. cars is up by around 0.4% m/m.  

Assessment & Outlook: The report implies that Q3 spending is tracking slightly above 3% q/q AR. This is somewhat higher than our current forecast of 2.5% q/q AR. A part of this upside has most likely been taken out of inventories. Hence, it will not all turn up in Q3 GDP growth, as some of it will be pushed into Q4.  

The revival in personal consumption has come at the expense of a decline in the savings rate over the past couple of months. This decline is fully consistent with the clunker driven spending spree on cars and a delayed reaction on the increase in disposable income driven by the tax relief. With the impact from the clunkers programme leaving the equation we would not be surprised to see some increase in the savings rate in the coming months and a much slower rate of consumption growth in Q4.  

Looking forward, a recovery in the labour market is crucial for a sustained recovery in consumption. Negative wealth effects will prevent any further decline in the savings rate from the current levels. With very slow growth in hourly earnings this leaves employment growth
vital for underlying income growth. We expect that GDP growth above trend for the next couple of quarters will foster a return to positive private employment growth by late this year which should support positive although moderate growth in underlying personal spending.