German Ifo business climate deteriorates moderately in October driven by manufacturing and retail sectors / by Timo Klein

Frankfurt/Main (25.10.18) – In October, the headline Ifo business climate index reflecting conditions in industry, services, trade, and construction has declined to a moderate degree from 103.7 to 102.8. Given the interim 2.1-point bounce in August, the latest level still exceeds those observed during April-July, however. It is also still closer to the all-time (post-2004) high of 105.4 in November 2017 than to the long-term (2005-2018) average of 97.5 (let alone the post-Lehman all-time low of 80.1 in March 2009). Notwithstanding growing headwinds from various external developments (US protectionism, Iran sanctions, rising Brexit no-deal odds, Kashoggi affair), the underlying momentum of the German economy is abating only gradually.

That said, the Ifo institute comment on the latest data by stating that “growing global uncertainty is increasingly taking its toll on the German economy”. In any case, the broad-based Ifo data reflect more resilience of business optimism than other leading indicators, notably the purchasing managers’ index (PMI) and the ZEW data that are more concentrated on views in the manufacturing and financial sectors, respectively.

 

There was little difference between the expectations and current conditions components in October. The expectations index fell from 100.9 (revised down from 101.0) to a three-month low of 99.8. This remains above the 98.3 long-term (2005-2018) average, but it is now well below its cyclical high of 103.7 in November 2017, let alone the all-time peak of 106.2 in November 2010. The current conditions similarly declined from 106.6 (revised up from 106.4) to 105.9. Unlike the expectations component, this is still quite close to January’s all-time peak of 108.9, and the long-term average of 96.8 remains far off. Ignoring a single outlier in November 2014, the current conditions index has consistently been above its long-term average since mid-2013.

 

The October breakdown by sector, relating to manufacturing, services, trade, and construction, shows declines in the first three of these sectors (led by manufacturing) and a partially offsetting further increase in constructions sector sentiment to a fresh record high. The drop in the manufacturing sector component, which was led by expectations, took sentiment back to its lowest level since January 2017. Nevertheless, owing to the interim expectations rebound in August-September, the latest level still broadly equals the levels seen in mid-year. The Ifo institute does note that manufacturing orders inflow has weakened and that capacity utilization fell by 0.5 points to 87.1%. Meanwhile, service-sector slippage owed to current conditions alone, whereas expectations improved marginally. The reverse applied to the business climate in the trade sector, with deterioration also being mostly due to retailing rather than wholesaling. The former essentially unwound the previous month’s spike. Finally, the fourth consecutive all-time high in construction was due to current conditions, whereas expectations in the sector corrected slightly.

 

Overall, the October Ifo business climate survey indicates that even the domestically robust German economy cannot escape the impact from an array of negative external developments. Nevertheless, recent deterioration remains relatively limited so far, and it is important to note that the Ifo survey is the leading indicator that provides the broadest measure of what is going on in the German economy. As before, the robustness of domestic demand is being ensured by private consumption that is underpinned by above-average recent wage and pension increases and ongoing good labour market prospects and by a construction sector that is going from strength to strength due to persisting structural support from demographics, pent-up demand, and still very low interest rates.

 

The latest IHS Markit forecasts for (calendar-adjusted) GDP growth are 1.9% for 2018 and 1.6% for 2019. The latter has been adjusted downwards in October from 1.8% in September’s forecast round. This mirrors the emergence of further signs in the monthly hard data for an ongoing slowdown and the increasing odds for weakening growth in the US in the course of next year. The apparent fragility of Germany’s current government is a separate factor, with negative results in recent and upcoming regional elections for the parties that rule in Berlin potentially eroding Merkel’s power basis. 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 even more heavily on the economy. –

Best regards, Timo Klein