IHS: Expectations drive unexpected major rebound

of German Ifo business climate index in August

Frankfurt/Main (27.8.18) – In August, the headline Ifo business climate index reflecting conditions in industry, services, trade, and construction has unexpectedly rebounded in significant fashion from 101.7 to 103.8. This recoups more than half of the interim slippage observed since the all-time (post-2004) high of 105.3 in November 2017 and is well above its long-term (2005-2018) average of 97.4, let alone the all-time low of 80.0 in March 2009 (post-Lehman recession). The level at the data edge also of 101.7 is also marginally higher than the interim peak of 103.7 attained during the heyday of the post-Lehman recovery in November 2010, a time when GDP growth temporarily exceeded 4%.

 

The August recovery in business sentiment is very encouraging for the near-term outlook, confirming that underlying momentum of the German economy is firmly underpinned in the 2% area. The Ifo index had already corrected by less than other leading indicators (PMI, ZEW) during the first half of 2018, suggesting that the latter will rebound markedly during the autumn months. The Ifo institute comment on the latest data by stating that “next to strong domestic demand, the truce in the trade conflict with the US is contributing to improved sentiment”.

 

Importantly, the expectations component led the way in the August recovery. The index rebounded from 98.2 (revised down slightly from 98.3) to 101.2. This clearly exceeds its 98.3 long-term (2005-2018) average and compares to a cyclical high of 103.6 in November 2017 and an all-time peak of 106.2 in November 2010. The current conditions component also improved, increasing from 105.4 (revised up from 105.3) to 106.4. Although its recovery was more muted than that for expectations, it needs to be remembered that its all-time peak (108.6 in January) is much closer already. Accordingly, the gap with its long-term average of 96.7 is much larger. Ignoring an outlier in November 2014, the current conditions index has consistently been above its long-term average since mid-2013.

 

The August breakdown of the Ifo survey by sector, relating to manufacturing, services, trade, and construction, shows that the main boosting element was the service sector, followed by construction and manufacturing. The trade component increased only marginally as improving expectations were offset by a dip in current conditions, while construction posted yet another all-time high (this time enabled by expectations). Expectations were also the driving factor in manufacturing, especially in the automobile sector, whereas the assessment of current conditions weakened modestly once more. The Ifo institute add that more firms now plan to raise production. Finally, the service sector profited from concurrent gains in current conditions and (especially) the six-month outlook, the latter reaching a nine-year high.

 

Overall, the Ifo business climate survey in August suggests that recent growth stabilization may even be turning into renewed acceleration now. Although the Ifo institute point specifically to the truce in the US-EU trade conflict, it was not the manufacturing sector – arguably most sensitive to developments in international trade – but services that recovered the most at the data edge. This is consistent with the recovery of the PMI index for the service sector since its interim low in May. It confirms that persistently strong labour market conditions and particularly the above-average wage and pension increases of recent months are now giving fresh impulses to domestic demand. Furthermore, the construction sector has moved far into uncharted territory during July-August as it fully 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, to be released shortly, will be reduced from the July prediction of 2.2% to 1.9%. This largely owes to downward revisions to recent quarters that were revealed with detailed second-quarter GDP data on 24 August, however. The positive surprise of the August Ifo numbers has significantly raised the odds that the next forecast adjustment will be to the upside. Stabilizing monthly activity indicators such as production, exports, and retail sales since May had already suggested an imminent end to the phase of relative weakness that had begun around the run of the year, but now third-quarter GDP growth may even exceed the pace of 0.5% q/q that we have pencilled in. Note too that the federal statistics office reported on 24 August that the public-sector surplus in the first half of 2018 was an unprecedented EUR48.1 billion or 2.9% of GDP, giving the government ample leeway to loosen the fiscal reins. Admittedly, this large surplus overstates matters because of the post-election delay in forming a new government, postponing final passage of the new budget for 2018 to early July and thus forcing territorial authorities to provisionally base expenditures on the (lower) budget for 2017. Some caution also remains advised with respect to future developments in the trade conflict with the US, given US president Trump’s wayward behaviour, but the surge in Germany’s service-sector prospects nonetheless justifies the expectation of a quarterly GDP growth pace of at least 0.5% during the second half of 2018.

Best regards, Timo Klein