Germany’s Ifo business climate index corrects marginally

in August despite expectations remaining on the rise

 

Frankfurt/Main (25.9.17) – In September, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade declined somewhat further from July’s post-unification and thus post-1990 high of 116.1, slipping from 115.9 to 115.2. Nevertheless, even the latest level remains clearly above the levels seen during the heyday of the post-Lehman recovery of 2010-11, when GDP growth temporarily reached 4% (versus the 2.5-3.0% region in underlying terms at the current data edge).

Germany’s current business climate compares to an interim high of 108.7 just before the UK referendum on Brexit in June 2016, a long-term average of 102.1, and an all-time low of 83.7 in March 2009 in the wake of the Lehman collapse. The persistent strength of recent Ifo data contrasts somewhat with the downward corrections to ZEW levels around mid-year, but the ZEW index has rebounded in September and manufacturing PMI data has climbed to its highest level since April 2011. The Ifo institute comment on the latest data by saying that “the new legislative period nonetheless begins with a tailwind of strong business activity”.

 

The expectations component edged down from a three-and-a-half-year peak of 107.8 to 107.4, which remains well above its long-term average of 100.5. Current conditions did less well, extending the previous month’s decline from July’s 125.6 all-time peak by slipping from 124.7 to 123.6. This level nonetheless still exceeds its previous record set in mid-2011 at 121.7 in the context of the post-Lehman recovery. Note that the last time that the current conditions index has been below the present long-term average of 103.9 was more than seven years ago, and the last downward correction of some length (April-October 2014) bottomed at 108.5. Although international political uncertainty remains high due to the Brexit negotiations and wayward US economic policy developments, these factors are not weighing unduly on German business optimism. The same holds for the euro’s appreciation since May. At the same time, there is offsetting external support from a brighter European economic environment this year, especially after the election of Emmanuel Macron as French president.

 

Note that the release of the separate Ifo survey about the climate in the service sector – a series available since January 2005 – will now always be a day after the release about conditions in industry, construction, and wholesale and retail trade described above. In August, the services survey index (released on 28 August) has extended the previous month’s rebound, having declined between December 2016 and April and essentially stagnated in May-June. Following an all-time high of 35.8 in November 2016 and an interim low of 26.2 in June, the headline index has now increased from 29.8 to 31.2. This has narrowed the gap with recently outperforming business climate data for industry, construction, and wholesale and retail trade. The August improvement was driven by expectations, which increased from 14.3 to 17.9 (its long-term average is 11.7). This compares to an all-time high of 25.8 in November 2015. By contrast, current conditions in the service sector modestly corrected for their 7.2-point jump in July, slipping from 46.4 to 45.3. This remains close to their all-time high of 48.4 in November 2016 and is far above their long-term average of 25.3. The development of the last 18 months reveals that the overall service-sector index posted fresh gains during 2016 to eventually reach a record level in November 2016, then encountered a setback lasting until April this year, and has since rebounded anew. During the twelve-and-a-half years of history of this service sector series, expectations have fluctuated between -25.9 (December 2008) and 25.8 (November 2015), and current conditions between -12.1 (May 2009) and 48.4 (November 2016).

 

Meanwhile, the breakdown of the main Ifo survey by sector, relating to goods production and trade, reveals that improvements for construction and retail trade were more than offset by declines for manufacturing and especially whole trade. Optimism in manufacturing has retreated from the previous month’s record level, this owing more to worsened current conditions rather than expectations. It remains noteworthy how limited the impact of the important car industry’s woes (diesel emissions; accusations of violation against anti-trust laws) has been. Business climate in the wholesale sector worsened for the second consecutive month, returning to levels last seen in March-April. This decline was driven by expectations, but current conditions also contributed markedly. Meanwhile, the improvement for construction sentiment is an extension of recent increases, reaching yet another all-time high as both current conditions and expectations had a boosting impact. By contrast, the increase in retail sector sentiment represents only a partial rebound to large July-August declines, the latest level thus remaining well below June’s three-and-a-half-year high. The key restraining factor is still the reticence reported by car dealers.

 

Overall, the Ifo business climate report still paints a strong picture of the German economy, one which latest ZEW and PMI leading indicator data also aligns with. The construction sector, being structurally supported by factors such as demographics and persistently low interest rates, is increasingly becoming a key pillar of the current economic upswing in Germany. Retailer sentiment is skewed to some extent by relative pessimism in the car sector due to its various scandals, whereas positive labour market developments and the newly improving services-sector climate in July-August bode well for consumer demand in general.

 

The latest IHS Markit forecast for (calendar-adjusted) GDP growth, released in mid-September, is 2.3% for 2017 and 2.2% for 2018. Near-term underlying growth momentum is even at 0.6% to 0.7% q/q and thus at 2.4% to 2.8% annualized. Improved European growth prospects following the election of the reform-minded Emmanuel Macron to the French presidency will support Germany’s economy in the months ahead. Potentially disruptive developments linked to the Brexit negotiations and possible protectionist measures by the Trump administration in the US offset this at worst modestly. –

Best regards: Timo Klein