Germany’s Ifo business climate rebounds to fresh post-reunification high in October driven by both expectations and current conditions

Frankfurt/Main (26.10.17) – In October, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade rebounded after a two-month downward correction, increasing from 115.3 to a fresh post-reunification and thus post-1990 high of 116.7. Remarkably, this thus clearly exceeds the levels seen during the heyday of the post-Lehman recovery of 2010-11, when GDP growth temporarily reached 4% (versus the “mere” annualized pace of 2.5-3.0% 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 102.2, and an all-time low of 83.7 in March 2009 in the wake of the Lehman collapse. The record level at the data edge contrasts with somewhat less bullish indications from other leading indicators such as manufacturing PMI and especially the ZEW survey. The Ifo institute comment on the latest data by saying that “Germany’s economy is powering ahead”.

The expectations component rebounded from 107.5 to 109.1, its highest levels since December 2010 and well above its long-term average of 100.6. Current conditions improved by almost as much from 123.7 to 124.8, which remains only modestly below July’s all-time peak of 125.7 and clearly exceeds the mid-2011 record set in the previous cycle at 121.8 (then reflecting the post-Lehman recovery). Note that the last time that the current conditions index has been below the present long-term average of 104.0 was in early 2010, and the last downward correction of some length (April-October 2014) bottomed at 107.9. Although international political uncertainty remains high due to the Brexit negotiations and wayward US economic policy developments, these factors are apparently hurting 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 September, the services survey index (released on 26 September) slightly extended the July-August rebound, having shown a downward correction between December 2016 and June. Following an all-time high of 36.1 in November 2016 and an interim low of 26.1 in June, the headline index has now increased from 31.4 to 31.6. The gap with previously outperforming business climate data for industry, construction, and wholesale and retail trade thus narrowed during the summer months. The September improvement owed to expectations alone, which increased from 17.8 to 19.3 (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 deteriorated modestly foe the second consecutive month, slipping from 45.9 to 44.6. That said, this remains close to their all-time high of 49.2 in November 2016 and is far above their long-term average of 25.4. The development during 2016-17 reveals that the overall service-sector index initially recovered from a dip in early 2016, reaching a record level in November 2016, then experienced another setback during the first half of 2017 before rebounding anew. During the nearly 13 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 -11.9 (May 2009) and 49.2 (November 2016).

Meanwhile, the October breakdown of the main Ifo survey by sector, relating to goods production and trade, reveals improvements for all sectors except wholesale trade. Business climate in wholesaling has been slipping since it reached a cyclical high in July. By contrast, the sub-index for manufacturing not only rebounded but reached a new record, driven by both expectations and current conditions. Within manufacturing, investment goods producers, notably machine-builders, were the driving force for this optimism. This offset any lingering concerns of the automobile industry. Meanwhile, construction sentiment also reached yet another all-time high despite a slight downward correction of current conditions – expectations have really taken off in recent months. Finally, the business climate in the retail sector rebounded the most in October, exactly returning to June’s three-and-a-half-year high. In this case expectations and current conditions contributed evenly. Note too that retailers expressed rising intentions to hike their prices.

Overall, the Ifo business climate report paints a stronger picture than ever of the German economy. 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 has recovered sharply from an interim downward correction during the third quarter that was at least partly related to relative pessimism in the car sector due to its various scandals. The latest boost to retailer optimism is likely to also be reflected in the October services-sector survey due tomorrow (26 October), thus boding well for consumer demand in general.

The latest IHS Markit forecast for (calendar-adjusted) GDP growth, released in mid-October, is 2.3% for 2017 and 2.2% for 2018 (unchanged from September forecasts). Near-term underlying growth momentum revolves around 0.7% q/q and thus nearly 3% annualized. Improved European growth prospects following the election of the reform-minded Emmanuel Macron to the French presidency is currently providing additional support for the Germany economy. Potentially disruptive developments linked to the Brexit negotiations and possible protectionist measures by the Trump administration in the US hardly offset this anymore, especially as the most recent signals from the US suggest that tax cuts might be realized after all.

– Timo Klein, Principal Markit Economics