Again, although you give good descriptions, hard to say what's going on. What is the tail position on the terrier when the GSD is sniffing her? Still no age on the GSD...she might be backing down because she's still young and doesn't care for an altercation. Once she gets older (around a year, year and a half) she's going to mature, and more than likely put the small dog in its place. You have to stop the small dog from growling or showing teeth. That is the biggest thing...realizing that the small dog might be the problem and correcting the small dog because this is a life threatening situation for the small dog.
Remember...people interaction/socialization is different than dog interaction. Dogs can be great around people, but be very aggressive towards dogs. It sounds a little like the terrier is a little unsure and not very confident. My suggestion is to start training them together, do obedience with them together, take them for walks together. Let the terrier realize that she now has a sister in the household and that its necessary to get along.
If you were dealing with a bigger dog, I'd probably say that you could allow the dog to correct the younger dog, but because its a terrier...its just not safe to allow the terrier to correct the bigger GSD.
CD RE TC HIC 7/10