Germany: Third successive improvement of German Ifo business climate during January confirms strengthening economic recovery / IHS Global

Frankfurt/Main (26.1.15) – In January, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade increased for the third consecutive month, confirming that the eight-month decline to a 22-month low in October 2014 will not be resumed now. The index increased from 105.5 to 106.7, which is roughly in the middle between the starting level of the 2012/13 upward trend at 100.4 in October 2012 and its February 2014 interim high of 111.2 (last exceeded in mid-2011).

The downward correction of 2014 had been of a fairly sustained nature due to the concurrence of ongoing geopolitical concerns, especially about Ukraine/Russia and the IS threat in Iraq and Syria, and emerging market problems related to the US Fed’s shift towards less expansionary monetary policy. In contrast to the duration, the extent of last year’s setback (down from February’s 111.2 to 103.2 in October) was fairly moderate in a historical perspective. Thus the index had marked an historic low of 84.4 in March 2009 in the wake of the Lehman collapse and then climbed to an all-time peak of 115.0 in February 2011. The current level significantly exceeds the long-term average of 101.4 again now. Apparently, supportive global factors such as the ongoing massive oil price decline and the weakening euro have now filtered through to the bottom line at company level. The Ifo index rebound of the past three months is in line with the marked upward reversal of the ZEW index during the same period (although the latter has outperformed in terms of magnitude of the bounce) and conveys a somewhat stronger impression than only modestly improving purchasing managers (PMI) data observed around the turn of the year.

 

The Ifo survey component reflecting six-month expectations increased for the third month in a row from 101.3 (revised up from 101.1) to 102.0, which exceeds its (slightly revised) long-term average of 100.2. Prior to the downturn lasting throughout most of 2014 for expectations, this sub-index had hit a 35-month high of 108.3 in January 2014, which had represented the culmination point of a 16-month rebound from 94.3 in October 2012 (then the lowest level in more than three years). The Lehman related all-time low had been 78.6 in December 2008. Meanwhile, the current conditions component has also increased for the third successive month in January (following revisions), gaining from 109.8 to a six-month high of 111.7. It is worth keeping in mind that the April-October 2014 downward correction to eventually 108.2 never undercut the interim trough of 106.4 in December 2012, not to speak of the long-term average of currently 102.6. Given further improvement of the expectations sub-index, the current conditions component is now setting sights again on the March 2014 two-year high of 115.5 and potentially the all-time high of 122.1 seen in June 2011.

 

By contrast, today’s separate Ifo survey release about the climate in the service sector – a series available since January 2005 – reveals a modest downward correction after December’s major rebound. The headline service sector indicator slipped from 25.8, its second-highest level since mid-2011, to 24.5. This dip was mostly driven by the expectations component, which declined from 19.5 to 17.6 and thus unwound a small portion of December’s jump by almost nine points. Current conditions eased only slightly from 32.2 to 31.7. January’s level for service-sector expectations of 17.6 remains well above its long-term average of 10.1, which also applies to current conditions (31.7 versus long-term average of 21.3). Service sector confidence had followed a sideways tendency between mid-2012 and November 2013 before breaking out to the upside around the turn of the year 2013/14 and then establishing another sideways trend at the new elevated level. December/January levels data are close to the highs of 2010/11. During the ten years of history of this service sector series, expectations have fluctuated between -24.5 (December 2008) and 25.7 (November 2010), and current conditions between -10.7 (May 2009) and 37.8 (April 2007).

 

Meanwhile, the breakdown of the main Ifo survey by sector, relating to goods production and trade, reveals improvements in all categories except construction. The largest improvement of the business climate by far occurred in the retail sector, where current conditions increased sharply for the second consecutive month and expectations unwound December’s interim dip to return to their November level. The manufacturing sector posted its third consecutive increase, driven by both expectations and current conditions and accompanied by a brightening up of export expectations due to the weakening euro. Capacity utilization has increased by 0.4 points versus the previous quarter to 84.6%. Wholesalers also demonstrated improving confidence, although in this case a modest downward correction of expectations partly offset the boost gained from current conditions. The opposite picture was obtained from the construction sector, where a small improvement of expectations could not fully compensate for a moderate worsening of current conditions.

 

In sum, taking both goods and services related sectors into account, January Ifo business climate data corroborates the encouraging signals of the previous two months for the near-term outlook for the German economy. The burdening factors weighing on business confidence for most of 2014 – notably the uncertainty created by ongoing geopolitical tensions in the Ukraine and the Middle East and the inability of the Eurozone as a whole to embark on a meaningful economic recovery path – are increasingly being superseded by the supportive influence from large oil price and euro declines. Any tensions related to the Greek election that has now taken place do not appear to have negatively impacted Germany’s business climate. German economic activity is estimated to have picked up already during the final months of 2014 and should be accelerating further right now. This is being driven not only by said oil price and euro developments, but also by the persistence of extremely low short- and long-term interest rates and a consistently good competitive position in terms of relative productivity.

 

The IHS Global Insight January forecast for annual average GDP growth in 2015 is 1.6%, up from 1.5% in 2014. This refers to calendar-adjusted data – the 2015 forecast in non-adjusted terms is in fact 1.9%. German consumer demand was already robust in Q3 2014 and will strengthen further now in early 2015, fuelled by high nominal and – given near-zero inflation – real wage growth, ongoing employment gains, and extremely low interest rates that discourage saving. Overall, German annualized growth should return to a pace of 1.5-2.0% by Q1 2015 already.

Timo Klein Dipl. Volkswirt / Senior Economist