German Ifo business climate index weakens marginally in September due to manufacturing sector alone – by Timo Klein

Frankfurt/Main (24.9.18) – In September, the headline Ifo business climate index reflecting conditions in industry, services, trade, and construction has corrected only marginally from 103.9 (revised up from 103.8) to 103.7. This follows the previous month’s sharp, unexpected rebound by 2.2 points and thus remains close to the all-time (post-2004) high of 105.3 in November 2017. The September level also keeps well above the long-term (2005-2018) average of 97.5, let alone the all-time low of 80.1 in March 2009 (post-Lehman recession). Remarkably, the data edge level of 103.7 matches the interim peak attained during the heyday of the post-Lehman recovery in November 2010, a time when GDP growth temporarily exceeded 4%.

The latest data thus confirm that the August recovery in business sentiment was not a fluke, reassuring that underlying momentum of the German economy is firmly underpinned in the 2% area. The Ifo index reflects somewhat greater business optimism than the other important leading indicator, the purchasing managers’ index (PMI), but in both cases the manufacturing sector is exerting a restraining influence while service-sector demand is actually strengthening. The Ifo institute comment on the latest data by stating that “the German economy remains robust despite growing uncertainty”.

 

There was little difference between the expectations and current conditions components in September as both declined marginally. The expectations index edged down from 101.3 (revised up from 101.2) to 101.0, which compares to a 98.3 long-term (2005-2018) average, a cyclical high of 103.6 in November 2017, and an all-time peak of 106.2 in November 2010. The current conditions similarly slipped only slightly from 106.5 (revised up from 106.4) to 106.4. This is even closer to its all-time peak (108.8 in January of this year) than is the case for expectations, and the gap with its long-term average of 96.7 is much larger accordingly. Ignoring an outlier in November 2014, the current conditions index has consistently been above its long-term average since mid-2013.

 

The September breakdown by sector, relating to manufacturing, services, trade, and construction, shows a dichotomy between a modest setback in the manufacturing sector and additional increases elsewhere. Even this decline in manufacturing sector sentiment was only half as large as the rebound in the previous month, and it owed exclusively to another dip in current conditions, correcting anew from the record levels seen in late 2017. By contrast, manufacturing expectations are extending their August rebound, reaching their highest level since February, and the Ifo institute add that more firms are planning to expand production in the coming months. The improvement in the service sector was only marginal (and in this case owing to current conditions only), but the business climate increase in the trade component to a four-month high was more pronounced, driven by retailing and by current conditions and expectations alike. Finally, construction posted its third all-time high in a row, propelled by both of its components.

 

Overall, the September Ifo business climate survey reassures that the growth slowdown of the first half of 2018 is giving way to renewed acceleration now. This is happening despite the fact that the trade conflicts initiated by the US are continuing to weigh to some degree on the manufacturing sector that has a high exposure to demand from abroad. Growth is being underpinned by domestic demand, be it by the consumer who is encouraged by high recent wage and pension increases and ongoing good labour market prospects (thus boosting both service sector and retail trade), or be it the construction sector that is enjoying one record after another because of persisting structural support from demographics, pent-up demand, and still very low interest rates. The sectoral split is consistent with the latest PMI evidence, as the flash September data revealed a setback for manufacturing and a concurrent further increase in the service sector.

 

The latest IHS Markit forecast for (calendar-adjusted) GDP growth in 2018 is 1.9%, down from a forecast of still 2.2% in July due to the net downward revisions to recent quarters that were revealed in August. Due to the limited impact that data for the second half of a year has on that year’s annual average, that forecast can be reaffirmed, but the chances are increasing for a stronger GDP growth performance in 2019 than what we last predicted (1.8%). That being said, the July data for production, exports, and retail sales were weak, and risks stemming from global trade conflicts, Brexit, and the fragility of Germany’s current government continue to urge for caution too. On the bright side, Germany’s public finances are in such a healthy general state at present that the government could easily afford to provide fiscal support to demand should external events weigh heavily on the economy. –

Best regards,Timo Klein