Germany’s Ifo business climate slips slightly from post-reunification high in December as expectations correct from interim peak – by Timo Klein

 

Frankfurt/Main (20.12.17) – In December, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade edged down modestly from the previous month’s post-reunification and thus post-1990 high, posting 117.2 after November’s 117.6 (revised up from 117.5). This continues to exceed 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 about 3% at the current data edge).

Germany’s current business climate compares to an interim high of 108.8 just before the UK referendum on Brexit in June 2016, a long-term average of 102.3, and an all-time low of 83.8 in March 2009 in the wake of the Lehman collapse. The near-record level at the data edge contrasts with more restrained indications from the ZEW survey, but it is in line with the latest manufacturing PMI index that reached its highest level in over 21 years of survey history in December. The Ifo institute comment on the latest data by saying that “sentiment among German businesses is excellent ahead of Christmas, but no longer quite as euphoric as last month”, nonetheless adding that “German businesses are full of festive spirits.”

 

The expectations component was solely responsible for the correction, as it unwound most of November’s increase by slipping from 111.0 – which had been only just below its all-time high of 111.1 recorded in November 2010 – to 109.5. The long-term average of this component is 100.6. By contrast, current conditions rebounded from 124.5 (revised up from 124.4) to 125.4, which is only slightly below July’s all-time peak of 125.8. The latest level also clearly exceeds the previous cyclical high of 121.9 set in mid-2011 (then reflecting the post-Lehman recovery). Note that the last time the current conditions index has been below the present long-term average of 104.1 was in early 2010, and the last downward correction of some length (April-October 2014) bottomed at 108.0.

 

This ongoing bullishness in the Ifo survey is all the more remarkable given persistently high international political uncertainty due to the Brexit negotiations and wayward US economic policy developments and also elevated domestic political uncertainty after the failure to form a “Jamaica” coalition government and the likelihood that it will take several more months to find an alternative. In the event that new elections become unavoidable, a stable new German government might not be formed ahead of the second half of 2018. The euro’s appreciation during May-September has equally not visibly hurt German business optimism. It appears that all these negative factors are more than offset by a generally improving European economic environment and the psychological boost of May’s election of the pro-European Emmanuel Macron to the French presidency.

 

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 November, the services survey index (released on 27 November) encountered a small setback after a 4-month rebound from the observed during the first half of 2017. The headline index, which had declined from an all-time high of 34.8 in November 2016 to an interim low of 26.3 in June 2017, has now slipped from 33.3 to 32.6. The service-sector still underperforms the headline Ifo business climate data for industry, construction, and wholesale and retail trade, but no longer by as much as in the first half of 2017. The November dip owed exclusively to current conditions, where the sub-index declined from 47.0 (which had nearly matched July’s all-time high of 47.4) to 44.0. Nevertheless, this remains well above their long-term average of 25.7. Furthermore, the expectations component increased anew from 20.3 to 21.7. This compares to a long-term average of 11.8 and an all-time high of 25.7 in November 2015. 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 13 years of history of this service sector series, expectations have fluctuated between -26.0 (December 2008) and 25.7 (November 2015), and current conditions between -11.1 (May 2009) and 47.4 (July 2017).

 

Meanwhile, the December breakdown of the main Ifo survey by sector, relating to goods production and trade, reveals mixed developments. The sub-index for manufacturing fell back from November’s record high, which owed exclusively to a setback for expectations whereas the assessment of current conditions improved modestly due to a better orders situation. Business climate in the wholesale sector also slipped from an all-time high in the previous month, led by expectations but also owing to current conditions. By contrast, construction sentiment rebounded, although it failed to get back to October’s all-time peak. The construction indicator benefited from better current conditions as well as expectations. Finally, the business climate in the retail sector also recovered, reaching a level just modestly below October’s near-seven-year peak. The retail indicator displayed a marked dichotomy between a huge rebound in current conditions, reflecting excellent Christmas sales, and a setback for expectations as retailers failed to believe in any further improvement.

 

Overall, the Ifo business climate report continues to reflect a very strong German economy. Notwithstanding the correction for manufacturing, this sector remains very robust as it benefits from strengthening external trade, both globally and in Europe alone. The construction sector, being structurally supported by factors such as demographics and persistently low interest rates, also remains a key pillar of Germany’s economic upswing. This equally applies to retail trade, which has recovered in the final quarter of 2017 from an interim downward correction during the third quarter that was at least partly related to scandal-induced pessimism in the car sector. This view is bolstered by the improved sentiment in the service sector since mid-2017, which supports the impression of persistently robust consumer demand in general.

 

The latest IHS Markit forecast for (calendar-adjusted) GDP growth, released in mid-December, remains at 2.6% for both 2017 and 2018. 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 providing additional support for the Germany economy at present. Potentially disruptive developments linked to the Brexit negotiations and possible protectionist measures by the Trump administration in the US are largely ignored by German businesses currently, and this also applies to the unusual domestic difficulties in forming a new government after September’s elections. –

Best regards, Timo Klein