IHS Global: Current conditions slightly dampen German Ifo business climate in December, expectations and separate services index hold steady

Frankfurt/Main (17.12.15) – In December, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade retreated slightly following the previous month’s unexpected rebound, slipping from 109.0 to 108.7. This remains fairly close to the previous cyclical high of 110.9 seen in January/February 2014 and far above its long-term average of 101.5 and the October 2014 interim low of 103.6. Historic extremes are a low of 83.6 in March 2009 in the wake of the Lehman collapse and an all-time peak of 114.3 in December 2010.

The underlying improving tendency observed since November 2014 is still intact. There continues to be no indication that the Volkswagen scandal is having any wider negative implications for German industrial activity. In fact, the manufacturing sub-index was the only one to increase in December. The additional oil price decline and euro weakening since mid-October will have helped here. The Ifo institute points out that the latest index level of the business climate is roughly three points higher than a year ago. Note that Ifo index improvements since mid-2015 have recently also been reflected in upward tendencies of other leading indicators, notably the PMI and ZEW surveys.

In December, the expectations component of the Ifo business climate survey remained unchanged after three months of increases, which demonstrates that ongoing problems in many emerging markets (including China) and political uncertainty related to the sharp increase in refugee flows to Germany in recent months have at most restrained the upward trend of perceived economic prospects six months out. The relevant sub-index has steadied at November’s 18-month high of 104.7, which remains well above its long-term average of 100.3. It had deteriorated during 2014 from a 35-month high of 108.2 in January to 99.3 in October 2014, but much of this setback has been unwound by now (despite a renewed relapse during the second quarter). For comparison, the Lehman related all-time low had been massively lower at 78.6 in December 2008. Meanwhile, it was the current conditions component that has dampened the overall index during December, slipping from 113.4 to 112.8 and thus failing to confirm November’s rebound. That being said, the gap to the 16-month high of 114.9 in August or even the interim peak of 115.6 in March 2014 is not large, whereas the long-term average of currently 103.0 is not at risk any time soon. The underlying robustness of current conditions is also underlined by the fact that the most recent downward correction of some length (during April-October 2014) only extended to 108.1, thus failing to reach the interim trough of 106.4 seen in December 2012.

Furthermore, today’s separate Ifo survey release about the climate in the service sector – a series available since January 2005 – revealed yet another all-time high, albeit only marginally so. The headline services index increased from 33.6 (revised up from 33.4) to 33.7. In contrast to November, this was driven by the current conditions component this time, which rebounded from 40.4 (revised up from 40.1) to 42.8, getting close to its all-time high of 43.7 recorded three months ago in September (long-term average is 22.8). The expectations component fell back modestly from November’s all-time peak of 26.9 to 24.9 (long-term average is 10.8). The overall service-sector index had demonstrated a sideways tendency between mid-2012 and November 2013, followed by a break-out to the upside around the turn of the year 2013/14, and then another sideways trend at a new elevated level for a year. This has been replaced by a fresh upturn during 2015 that is still continuing. During the eleven years of history of this service sector series, expectations have fluctuated between -25.1 (December 2008) and 26.9 (November 2015), and current conditions between -11.1 (May 2009) and 43.7 (September 2015).

Meanwhile, the breakdown of the main Ifo survey by sector, relating to goods production and trade, shows that only the manufacturing sector managed to improve anew. The wholesale trade index declined the most, whereas the slippage observed for retail trade and construction was fairly limited. The business climate in the manufacturing sector has posted its second increase in a row, thus now having unwound about 60% of the decline seen during May-October. Encouragingly, expectations were the driving element in manufacturing, and firms are said to be revising their production plans upward at present. Sentiment in the building sector has softened only slightly after having reached a new post-unification and thus 25-year high the month before. In this case, expectations deteriorated a little, while the assessment of current conditions improved further. The third consecutive decline in retailer climate needs to be seen against the background of the exceptional spike seen in August/September, which has not been fully unwound yet. Furthermore, expectations rebounded a little, so that current conditions, which are still at higher levels than during the first half of 2015, are solely to blame. Indeed, unusually mild weather in recent weeks has been hurting clothes sales while helping the building industry. Macroeconomic conditions remain very favourable for consumers, which can also be gleaned from the above-mentioned new all-time high of the Ifo service-sector survey this month. Finally, the business climate in wholesale trade experienced a somewhat larger setback versus November’s 22-month high, owing to both current conditions and expectations.

Overall, the December Ifo business climate report continues to support the view that German economic growth will remain robust in the months ahead, driven by consumption and increasingly probably also construction. At the same time, although net exports will probably not help economic growth due to imports gaining additional momentum, the outlook for exports on their own is not bad at all either. Improving demand from the US, the UK, and the Eurozone at large are compensating for weakness in many emerging markets including China. This also applies to the helpful influence of yet lower oil prices, an even weaker euro, and persistently low interest rates. It should also be kept in mind that the near-term impact of the refugee crisis on the economy will be positive, as credit-financed government consumption needs to be raised. German GDP growth is expected to fluctuate around the 2% mark in annualized terms during the coming quarters.

The December IHS forecast for annual average GDP growth in 2015 has been kept at 1.5%, following 1.6% in 2014. This refers to calendar-adjusted data – the 2015 forecast in non-adjusted terms is in fact even 1.8%. German consumer demand has been growing at a pace of around 0.5% q/q since mid-2014 and this should be maintained at least during the next few quarters. High nominal and – given near-zero inflation – real wage growth, ongoing employment gains, and extremely low interest rates that discourage saving are all factors bolstering consumer spending. For 2016, our GDP growth forecast remains at 2.0%, which translates to 2.1% in non-adjusted terms.

Von Timo Klein Dipl. Volkswirt Senior Economist IHS Economics – Western Europe