IHS Global: Germany’s Ifo business climate returns to November 2017 post-reunification high in January despite further slippage in expectations

 

Frankfurt/Main (26.1.18) – In January, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade unwound December’s small dip, increasing from 117.2 to 117.6 and thus returning to November’s post-reunification and thus 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 buoyant Ifo data are broadly in line with very elevated recent PMI numbers. Although the indications from the ZEW survey are somewhat more restrained, the overall impression for the economic outlook gleaned from leading indicators is very strong. The Ifo institute comment on the latest data by saying that “the German economy made a dynamic start to the year.”

 

That being said, the expectations component corrected downwards for the second month in a row, declining from 109.4 (revised down from 109.5) to 108.4. This compares to a cyclical high of 111.0 in November 2017 and an all-time peak of 111.1 in November 2010. The long-term average of this component is 100.7. The reason for the rebound of the headline Ifo index is therefore the current conditions component, which surged from 125.5 (revised up from 125.4) to a fresh all-time record of 127.7. Note that the last time the current conditions index has been below the present long-term average of 104.2 was in early 2010, and the last downward correction of some length (April-October 2014) bottomed at 108.1.

 

This ongoing bullishness in the Ifo survey is all the more remarkable given persistently high international political uncertainty due to the Brexit negotiations, wayward US economic policy developments, and persisting domestic political uncertainty during the sample collection period of the January Ifo survey if and when a new German government can be formed without having to stage new elections. The euro’s appreciation since May 2017 – accentuated in recent weeks – has equally had only a modest dampening effect on expectations. It appears that all these negative factors are more than offset by a generally improving European economic environment.

 

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 December, the services survey index (released on 20 December) rebounded after November’s short-lived setback. The headline index, which had declined from an all-time high of 34.9 in November 2016 to an interim low of 26.6 in June 2017, has increased from 32.7 to 33.7. The service-sector still underperforms the headline Ifo business climate data for industry, construction, and wholesale and retail trade, but by far less than in the first half of 2017. The December recovery owed mostly to current conditions, which rebounded from 44.3 to 46.1 and thus came close to the July 2017 all-time high of 47.7 (long-term average 25.9). The expectations component, which had already gained anew in November, edged up from 21.7 to 22.0. This compares to a long-term average of 11.9 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 -10.9 (May 2009) and 47.7 (July 2017).

 

Meanwhile, January’s breakdown of the main Ifo survey by sector, relating to goods production and trade, again reveals mixed developments. The sub-index for manufacturing unwound the previous month’s dip to return to the November 2017 record high, but it is important to note that this was exclusively due to surging current conditions whereas expectations corrected for the second consecutive month. The Ifo institute mentions that capacity utilization in the sector rose by 0.6 percentage points to 87.9%, far above the long-term average of 83.7%. The other sector showing an improving business climate was wholesaling, although the sub-index failed to return to the November 2017 all-time high. By contrast, construction sentiment suffered a small setback, showing the same pattern of improving current conditions but declining expectations as the manufacturing sector. Finally, the business climate in the retail sector also declined modestly, in this case owing to a small correction of current conditions (these had surged in December due to good Christmas sales) whereas expectations rebounded slightly.

 

Overall, the Ifo business climate report continues to reflect a very strong German economy. The manufacturing 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. Wholesale and retail trade remain close to cyclical or even all-time highs too, demonstrating that the current economic upswing is broad-based. 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 in 2018, released in mid-January, is 2.8%. This represents an upward adjustment from a prediction of 2.6% a month earlier, and it compares with a preliminary figure of 2.5% in 2017. Near-term underlying growth momentum revolves around 0.7% q/q and thus roughly 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 the September 2017 elections. The unexpected degree of euro strengthening in recent weeks arguably represents the main near-term risk for Germany’s exports.

Timo Klein. Principal Economist  HIS Frankfurt