German Ifo business climate index holds its ground in July as stellar construction sector performance supports / By Timo Klein

Frankfurt/Main (25.7.18) – In July, the recently introduced new headline Ifo business climate index reflecting conditions in industry, services, trade, and construction has slipped only marginally from 101.8 to 101.7. This compares to an all-time (post-2004) high of 105.2 in November 2017, a long-term (2005-2018) average of 97.4, and an all-time low of 79.9 in March 2009 during the post-Lehman recession. Note the July level of 101.7 is also still fairly close to the interim peak of 103.6 attained during the heyday of the post-Lehman recovery in November 2010, a time when GDP growth temporarily exceeded 4%. By contrast, the underlying momentum of the German economy is only in the 2% area at present.  The downward correction of the Ifo data since late 2017 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. Meanwhile, the Ifo institute comment on the latest data by stating that “the German economy is maintaining its expansion course (but) at a slower pace”.

The expectations component has declined modestly from 98.5 (revised down from 98.6) to 98.3. This exactly matches its long-term (2005-2018) average 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 has rebounded marginally from a 12-month low of 105.2 (revised up from 105.1) to 105.3. This remains much closer to its recent all-time peak (108.5 in January) than is the case for expectations. Accordingly, July’s 105.3 continues to be far above the long-term average of 96.6. The last time the current conditions index fell beneath its long-term average in a sustained manner was in 2013.

The July breakdown of the Ifo survey by sector, relating to manufacturing, services, trade, and construction, shows that a fresh surge of the construction sector index to a new all-time high (boosted predominantly by current conditions) was the main reason for the headline Ifo index holding its ground. That said, demand in the service sector also improved modestly, and only the manufacturing and trade sectors posted moderate further declines. With respect to the two latter sectors, current conditions rather than expectations were responsible for the latest slippage in manufacturing, whereas the opposite was observed in the trade sector (retail expectations in particular suffered). The Ifo institute add that momentum in the manufacturing sector has waned but that capacity utilization remained steady at 87.7%.

Overall, the Ifo business climate survey corroborates the impression already gleaned since May that the cooling-off phase after the economic boom of 2017 has turned into stabilization at still quite robust growth levels. Thus, the manufacturing sector, which is arguably most at risk from ramifications of the current trade conflict with the US due to their high export share, is proving to be surprisingly resilient. In addition, the service sector has now clearly stabilized, which is in line with the mid-year recovery of the PMI index for the service sector. This improves the consistency with persistently strong labour market conditions (including recently accelerating wage growth). Finally, the construction sector is establishing one record after another as it benefits from 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-July, remains at the 2.2% level already predicted in June. This has been adjusted downwards in several steps since March (then 2.8%) in reaction to weakening leading indicators, disappointing first-quarter GDP growth of 0.3% q/q, and weak monthly activity indicators such as production, orders, and exports during January-April. A sharp recovery in May has corroborated our expectation of a GDP rebound of 0.7% q/q in the second quarter, which we are also anticipating for corrective reasons – the first quarter was artificially depressed by several one-off factors such as metal sector strikes, an unusually large flu epidemic, early Easter, and a post-election delay to a new government and thus also a regular budget for 2018. Nevertheless, the persisting potential for an escalation of the trade conflict with the US continues to urge for caution, and on balance we expect a calming of GDP growth to the 0.4-0.5% area during the remainder of 2018. We currently predict growth in 2019 at 1.8%.

Best regards, Timo Klein