Ifo business climate index stabilizes in May after five-month decline, construction sector at fresh all-time high

 

Frankfurt/Mai (25.5.18) – In May, the new headline Ifo business climate index reflecting conditions in industry, services, trade, and construction has stopped the five-month decline that had started at an all-time (post-2004) high of 105.2 in November 2017, stabilizing at 102.2 (with April revised up from 102.1 initially). It needs to be remembered that this level is only modestly lower than the interim peak of 103.5 attained during the heyday of the post-Lehman recovery in November 2010, when GDP growth temporarily exceeded 4%. By contrast, the underlying momentum of the German economy is only in the 2% area at present.

The May business climate level of 102.2 also remains well above its (2005-2018) long-term average of 97.3, let alone the all-time low of 79.8 in March 2009 during the post-Lehman recession. The downward correction of the Ifo data in recent months remains more limited than that of other leading indicators such as the PMI and ZEW surveys. On balance, Germany’s economic outlook thus remains quite solid despite the correction from the unsustainably high levels of late 2017. Meanwhile, the Ifo institute comment on the latest data by stating that the German economy is coping well in a “difficult global situation”. They also say that – together with other indicators – these business climate data point to quarterly GDP growth of 0.4% q/q in the second quarter.

 

The new expectations component has slipped marginally further from 98.7 to 98.5. This is now almost even with its long-term (2005-2018) average of 98.3 and compares to a cyclical high of 103.7 in November 2017 and an all-time peak of 106.2 in November 2010. Meanwhile, the current conditions component, which had already held up better than expectations in April, even rebounded slightly from 105.8 (revised up from 105.7) to 106.0. This remains quite close to its all-time peak of 108.3 in January and far above its long-term average of 96.5.  The last time the current conditions index fell beneath its long-term average in a sustained manner was in 2013.

 

The May breakdown of the Ifo survey by sector, now relating to manufacturing, services, trade, and construction, looks even more benign as shows all sectors saw an improving business climate except for manufacturing – and the latter posted only a slightly dip. Admittedly, however, the expectations component only improved in the service sector, whereas it stayed roughly unchanged in the trade sector and deteriorated modestly in manufacturing and construction. The overall construction sector index nonetheless reached a new all-time high because current conditions rose sharply further into uncharted territory. Ironically, the service sector was the only one to display slippage in the assessment of current conditions, despite their improving expectations. The Ifo institute point out with respect to the manufacturing sector that current demand and also the stock of orders have improved lately.

 

Overall, the new Ifo business climate survey underlines that the cooling off of the economic boom of 2017 must not mean there will be a continuing slide to stagnation or even recession in the coming months. Unsurprisingly, the sector most affected by the recent downturn is manufacturing, given the importance of exports for these firms and the uncertainty about global trade developments caused by policy decisions of the Trump administration in the US that support protectionism and sanctions against anyone not wanting to bend to their will. The May improvements in the services and trade sectors render these data more consistent again with persistently strong labour market conditions (including accelerating wage growth most recently following high wage settlements). Finally, construction will remain strong in any case, based on ongoing structural support from demographics, pent-up demand, and still very low interest rates.

 

The latest IHS Markit forecast for (calendar-adjusted) GDP growth in 2018, released in mid-May, is 2.4%. This has been adjusted downwards in the last two months from a forecast of 2.8% during Q1, reflecting disappointing first-quarter GDP growth of only 0.3% q/q and the slippage of both leading indicators and hard data such as production and exports in recent months. We do expect a technical rebound of as much as 0.8% q/q in the second quarter, however, owing to the first quarter having been artificially depressed by a number of one-off factors (metal sector strikes, an unusually large flu epidemic, early Easter, post-election delay to new government and thus also a regular budget for 2018). Thereafter, a calming to the 0.5% area is expected, with risks being to the downside in case of either an escalating trade/sanctions conflict with the US or major political disruptions in the EU linked to the incoming populist government in  Italy. At present, we still expect growth of 2.0% in 2019, however.

– Best regards, Timo Klein