IHS: German Ifo business climate index encouragingly extends rebound in August as retail sector reaches four-year high

Frankfurt/Main (25.8.15) – In August, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade extended the previous month’s rebound, increasing from 108.0 to 108.3. April’s interim high of 108.7 is thus coming into sight again. Current conditions were solely responsible for the renewed increase, however, whereas the expectations component slipped marginally. The overall index level of 108.3 compares favourably to a long-term average of 101.4 and the October 2014 low of 103.7, and it is also fairly close to its February 2014 interim peak of 110.9. The May/June dip – by just -1.2 points cumulatively – and the recovery in July/August can be attributed to developments surrounding Greece and possibly also the recent nuclear deal reached with Iran. By comparison, the downward correction during March-October 2014 (extent: -7.2 points) had been linked to geopolitical concerns linked to Ukraine/Russia and the IS threat in Iraq and Syria as well as to emerging market problems caused by the US Fed’s shift towards less expansionary monetary policy. The historic extremes of the headline Ifo business climate index are a low of 83.6 in March 2009 in the wake of the Lehman collapse and an all-time peak of 114.4 in December 2010. The massive oil price decline and extensive weakening of the euro since mid-2014 remain important supportive factors for German companies. Ifo index developments since November 2014 continue to convey a stronger impression than the ZEW survey and the PMI data.

The Ifo survey component reflecting six-month expectations declined marginally from 102.3 (revised down from 102.4) to 102.2, having previously already weakened modestly since hitting an interim high of 103.9 in March. The level of 102.2 nonetheless still exceeds its long-term average of 100.3. The expectations sub-index had already deteriorated during 2014 from a 35-month high of 108.2 in January 2014 to 99.3 in October 2014, before rebounding in part to 103.9 in March. For comparison, the Lehman related all-time low had been massively lower at 78.6 in December 2008. Meanwhile, the current conditions component increased from 113.9 to 114.8, establishing a new 16-month high and thus approaching the March 2014 two-year high of 115.4. The underlying robustness of current conditions is also underlined by the fact that the interim April-October 2014 downward correction to eventually 108.3 never undercut the interim trough of 106.6 in December 2012, not to speak of the long-term average of currently 102.8. That being said, the all-time high of 122.0 (June 2011) will most likely remain out of reach in the foreseeable future given ongoing Eurozone debt crisis uncertainties and the latest concerns about the Chinese economy.

Meanwhile, today’s separate Ifo survey release about the climate in the service sector – a series available since January 2005 – revealed significant improvement across the board. Indeed, the headline services index has risen from 26.0 to a new all-time high of 30.6. Furthermore, unlike developments of the main Ifo business climate survey described above, this was driven to a somewhat larger by the expectations component, which rebounded from 14.9 to 20.2 (long-term average is 10.4). Current conditions nonetheless also improved from 37.6 to 41.5, a fresh all-time high and thus also significantly above their long-term average of 22.1. Overall 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 a new elevated level for a year – which has now been left behind for yet higher territory in recent months. During more than ten years of history of this service sector series, expectations have fluctuated between -25.0 (December 2008) and 26.0 (November 2010), and current conditions between -12.6 (May 2009) and 41.5 (August 2015).

Meanwhile, the breakdown of the main Ifo survey by sector, relating to goods production and trade, reveals that the chief factor responsible for the further increase in August was the retail trade sector, with construction helping too. By contrast, manufacturing and wholesale trade slipped slightly. In the latter case, this only represents a breather after July’s massive surge in its current conditions – indeed, wholesaler expectations improved further in August. The opposite pattern was observed for the manufacturing sector, where rebounding current conditions could not fully compensate for slipping expectations. The August Ifo report again made no mention of manufacturers’ export prospects, but it stated that fewer companies were planning to expand production. Meanwhile, the retail sector was the star performer in August, reaching its highest level since June 2011. Both current conditions and expectations brightened up significantly. This picture is fully in line with extremely favourable macroeconomic conditions for consumers and also ties in with the all-time high of the Ifo service-sector survey this month. Finally, the construction sector resumed the upward tendency seen since April that was briefly interrupted in July. Driven by both current conditions and expectations, construction sector climate has reached the highest level since March 2014. In any case, it should be remembered that current building sector conditions are at historically elevated levels that exceed by far those seen during a near-20-year period between 1992 and 2010.

Overall, the August Ifo business climate report underlines the strength in underlying domestic demand and of private consumption in particular, which is making the economy quite resilient to any external shocks like that emerging from developments in China right now. Furthermore, the Eurozone as a whole is no longer as fragile as was the case during 2009-2013, which bodes well even for Germany’s exports. The supportive influence from additional recent oil price declines, a still subdued level of the euro, and extremely low interest rates should also not be forgotten. The economic difficulties in major emerging markets will thus restrain achievable German growth momentum but derail the upswing as such. German GDP growth is expected to fluctuate around the 2% mark in annualized terms during the coming quarters.

The latest IHS forecast for annual average GDP growth in 2015 is 1.7%, up from 1.6% in 2014. This refers to calendar-adjusted data – the 2015 forecast in non-adjusted terms is in fact even 1.9%. German consumer demand has been growing at a pace of around 0.5% q/q since mid-2014 and should maintain this momentum during the second half of 2015 despite the setback to only 0.2% q/q in Q2, which we would regard as an outlier. High nominal and – given near-zero inflation – real wage growth, ongoing employment gains, and extremely low interest rates that discourage saving are all factors that are bolstering consumer spending. For 2016, our current GDP growth forecast is 2.1%, which translates to 2.2% in non-adjusted terms. Timo Klein Dipl. Volkswirt / Senior Economist
IHS Economics  – Western Europe