Germany’s Ifo business climate declines only modestly in March as construction sector sentiment improves against general trend

 

Frankfurt/Main (22.3.18) – In March, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade extended the previous month’s setback, having posted a post-reunification and thus post-1990 high of 117.6 in January. It declined modestly from 115.4 to 114.7, which is still slightly higher than the interim peak of 114.3 attained during the heyday of the post-Lehman recovery of 2010-11. At that time, GDP growth had temporarily reached 4%, which compares favourably with the “mere” annualized pace of 2.5-3.0% at the current data edge. The March business climate level of 114.7 also continues to exceed by far the long-term average of 102.4, let alone the all-time low of 83.5 in March 2009 observed in the wake of the Lehman collapse. The February-March downward correction of the Ifo data is clearly less pronounced that those of other leading indicators such as the PMI and ZEW surveys lately. On balance, Germany’s economic outlook remains quite strong despite the recent correction of leading indicators.

The expectations component declined for the fourth month in a row from 105.4 to 104.4. This is down from a cyclical high of 111.0 in November 2017 and an all-time peak of 111.2 in November 2010. The latest level remains clearly above its long-term average of 100.7. The current conditions component, which had posted an all-time record of 127.8 in January, has declined modestly from 126.4 to 125.9. This is still the third-highest level ever, and the last time the current conditions index has been below the present long-term average of 104.3 was in early 2010.

 

The Ifo institute suggests that the threat of trade protectionism (as instigated by the US) is newly weighing on business optimism. By contrast, no further mention has been made either of euro appreciation or of disappointment about the economic policy plans of the new grand coalition government that has now been inaugurated.

 

Note that the separate Ifo survey about the climate in the service sector – a series available since January 2005 – is now always released one day after the survey concerning conditions in industry, construction, and wholesale and retail trade described above. In February, the services survey index (released on 23 February) extended the previous month’s moderate setback, driven exclusively by expectations. The headline index, which had posted an interim high of 34.1 in December 2017 that almost matched its all-time high of 35.2 in November 2016, has slipped from 32.6 to 31.2. The most recent performance of the service-sector survey is therefore comparable to that of the headline Ifo business climate survey for industry, construction, and wholesale and retail trade, whereas it had clearly underperformed during the first half of 2017. The expectations component of the service-sector survey fell quite sharply for the second month in a row from 17.0 to 13.4, which is now only modestly above its long-term average of 11.9 and well below the all-time high of 25.7 reached in November 2015. By contrast, current conditions actually managed improved anew from 49.3 to a fresh all-time high of 50.5 (long-term average 26.2).  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 -10.2 (May 2009) and 50.5 (February 2018).

 

Meanwhile, the March breakdown of the main Ifo survey by sector, relating to goods production and trade, shows some distinct differences this time. Expectations mostly deteriorated, with the exception of the construction sector where this component was even the driving factor for an overall improvement.  The business climate deteriorated sharply in retail trade and moderately in the manufacturing sector, while sentiment in the wholesale sector remained steady. In retail trade, the driving element for the drop was current conditions, whereas in manufacturing and the wholesale sector it was expectations alone that deteriorated. The Ifo institute added with respect to the manufacturing sector that the demand situation remains good and that firms continue to plan to expand production, albeit with less momentum than previously.

 

Overall, the Ifo business climate survey levels in March still reflect a very robust German economy, but some of the froth seen around the turn of the year has come off now. Manufacturing sector sentiment newly suffers from concerns about potential protectionist measures and retail trade encountered another marked setback that is harder to explain – especially as the service-sector, which is also closely connected to consumer sentiment and demand, has not displayed any worsening of similar magnitude lately. By contrast, the construction sector finally reflects the orders surge of late 2017, having already been structurally supported all along by demographics and persistently low interest rates.

 

The latest IHS Markit forecast for (calendar-adjusted) GDP growth in 2018, released in mid-March, is 2.8% (unchanged from the January and February forecast rounds). This compares with 2.5% in 2017 and an anticipated slowdown to 2.0% in 2019. The quarterly pattern is expected to show an interim peak of as much as 0.9% q/q in the first quarter, as this should benefit from a bounce back from relatively subdued GDP growth in the final quarter of 2017 and strong orders towards the end of last year. Thereafter, momentum should wane towards a pace of 0.5% q/q in late 2018 and in 2019. This development will reflect the additional uncertainty about trade protectionism and lagged effects of euro strengthening during December-January.

– Best regards, Timo Klein