Spain: Mixed results for the retail sales index.

The graph above raises more questions about Spanish consumer spending than it answers. Clearly, the medium term trend of the rate of growth in Spain's retail sales index (the trend line is in yellow, the index itself is plotted in dark blue) is up.

The upward slope is modest to be sure-without the trend line, the rate of increase looks almost flat-but the fact that the trend persists over 28 months, and considering the volatility of retail sales, it is more likely than not that the trend will persist for the near term.

Other than relatively favorable statistics, a fundamental reason for suspecting that consumer spending will remain strong is the fact that much of the spending can be accounted for by the creation of new households. And new households need to spend not only on durables, but on consumables as well.

Recently, though, opinion in the international financial press has begun to question the strength Spanish consumer spending. Some observers, notably BNP Paribas, the Paris based international banking network in a May 25, 2007 review of the Spanish economy, have raised the prospect that the country's economy is rebalancing. Emphasis, says BNP, is moving away from households and toward other sectors of the economy. "The breakdown between residential and non-residential investment is not yet available but, in all likelihood, non-residential investment was the main boost of activity."

The March 2007 increase in Spain's retail sales index as shown in the graph on page 1 (7.1 percent) is only slightly less than the record for the period shown (7.3 percent in April 2005.) And the drop to a rate of growth to 3.2 percent in April 2007 is far less than the 0.4 percent low point (for the period) recorded for April 2006.

In spite of the fact that there is a clearly cyclical quality in the rise and fall of the retail sales index, the sharpness of the drop in April 2007 is deserving of an explanation.

One explanation comes from the Economist Intelligence Unit (EIU) (London) on May 3, 2007. The EIU attributes Spanish consumer spending exuberance to a household wealth effect. And there is general agreement on this. But the EIU says that the recent cooling of the Spanish housing market, some would say a veritable cold snap with the precipitous decline of real estate stocks on the Madrid exchange on April 24, 2007, has undercut consumer confidence.

This is somewhat at odds with the PNB analysis, which predicts a soft landing for Spain's real estate market.

Rather, consumer spending may have declined so sharply because of the mandatory indexing of household mortgages. BNP says, "The ECB's monetary tightening has resulted in an automatic increase in interest expenses shouldered by households, as most mortgage loans are indexed to short-term interest rates, on average 1.5 percentage points above the euribor [Euro Interbank Offered Rate]."

The indexing causes a significant rise in mortgage payments households must make, which automatically reduces the amount of household disposable income. Combined with the volatile retail cycle, the mortgage penalty is likely the explanation for the sharpness in the drop of Spain's retail sales index.

Notable also are tax breaks, which could enhance the rebound in consumer spending for the next retail cycle.

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