IHS: Improving German November Ifo business climate confounds negative market expectations, separate services index reaches another all-time high

 

Frankfurt/Main (26.11.15) – In November, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade unexpectedly rebounded quite convincingly from 108.2 to 109.0, its highest level since June 2014 and newly approaching the previous cyclical high of 110.9 seen in January/February 2014. The overall index level of 109.0 also compares favourably to a long-term average of 101.5 and the October 2014 interim low of 103.6. Historic extremes are a low of 83.6 in March 2009 in the wake of the Lehman collapse and an all-time peak of 114.4 in December 2010.

The improving tendency observed since November 2014 thus encountered only a brief Greece related setback in May/June, and the Volkswagen scandal does not seem to be impacting negatively at all. To the contrary, the climate index for the automobile sector alone even increased during both October and November – a strong indication that any concerns about negative repercussions on the international reputation of German industry at large seem without foundation. The massive oil price decline and extensive weakening of the euro since mid-2014 remain important supportive factors for German companies. The Ifo institute points out that even the terrorist attacks in Paris on 13 November have not markedly hurt the business climate among the 20% of responses arriving after this date. Note that the further improvement of the Ifo index in recent months has been accompanied by increases of other leading indicators lately, including even the ZEW survey in November.

 

In November, the expectations component per se posted its third consecutive increase, providing counterfactual evidence to the common perception of worsening global growth prospects because of developments in emerging markets (including China) and problems related to the sharp increase in refugee flows to Germany in recent months. The Ifo survey component reflecting six-month expectations increased from 103.9 to an 18-month high of 104.7 that is now well above its long-term average of 100.3. The expectations sub-index had deteriorated during 2014 from a 35-month high of 108.2 in January to 99.3 in October 2014 before rebounding. This rebound was interrupted only temporarily during the second quarter. For comparison, the Lehman related all-time low had been massively lower at 78.6 in December 2008. Meanwhile, the current conditions component also rebounded after an interim setback during September-October, increasing from 112.6 to 113.4. This compares to a 16-month high of 114.9 in August and a two-year high of 115.6 back in March 2014. The underlying robustness of current conditions is underlined by the fact that the interim April-October 2014 downward correction to eventually 108.0 never undercut the interim trough of 106.7 in December 2012, not to speak of the long-term average of currently 102.9.

 

Furthermore, today’s separate Ifo survey release about the climate in the service sector – a series available since January 2005 – revealed yet another all-time high. The headline services index increased from 32.5 (revised up from 32.4) to 33.4. This was driven by the expectations component, which increased from 24.3 to an all-time peak of 26.9 (long-term average is 10.7). The current conditions component, which had established its own all-time high at 43.4 in September, has declined modestly from 40.9 to 40.1 (long-term average 22.6). The headline service-sector index had demonstrated a sideways tendency between mid-2012 and November 2013, followed by a break-out to the upside around the turn of the year 2013/14, and then another sideways trend at a new elevated level for a year. This has been replaced by a fresh upturn during 2015. During almost eleven years of history of this service sector series, expectations have fluctuated between -25.1 (December 2008) and 26.9 (November 2015), and current conditions between -11.4 (May 2009) and 43.4 (September 2015).

 

Meanwhile, the breakdown of the main Ifo survey by sector, relating to goods production and trade, shows broad-based improvements with the sole exception of retail trade, which has now partially corrected for a surge in August/September. The business climate in the manufacturing sector has finally rebounded markedly after a six-month downward trend, with expectations contributing to a somewhat larger degree than current conditions. Firms plan to expand their manufacturing output in the coming months. Sentiment also improved in the building sector, reaching a new post-unification and thus 25-year high. This owed mostly to better current conditions, while expectations consolidated their steep gains since the second quarter. The business climate in wholesale trade improved only modestly, nonetheless reaching its highest level since January 2014. As in manufacturing, rising expectations led the way. The setback observed in the retail sector, in this case entirely caused by worsening expectations against persistently optimistic views about current conditions, needs to be seen against the background of the sharp rebound during August/September. Macroeconomic conditions remain very favourable for consumers, which can also be gleaned from the expectations-driven new all-time high of the Ifo service-sector survey this month.

 

Overall, the November Ifo business climate report provides further evidence that German economic growth will remain robust in the months ahead, driven by consumption and increasingly probably also construction. These elements are shielding the growth performance from the burden of negative net exports. In any case, exports on their own are being supported by improving demand from the US, the UK, and the Eurozone at large, which compensates for weakness in many emerging markets including China. This also applies to the helpful influence of ongoing low oil prices, an even weaker euro, and extremely low interest rates. It should also be kept in mind that the near-term impact of the refugee crisis on the economy will be positive, as credit-financed government consumption needs to be raised. German GDP growth is expected to fluctuate around the 2% mark in annualized terms during the coming quarters.

 

The latest IHS forecast for annual average GDP growth in 2015 is 1.5%, following 1.6% in 2014. This refers to calendar-adjusted data – the 2015 forecast in non-adjusted terms is in fact even 1.8%. German consumer demand has been growing at a pace of around 0.5% q/q since mid-2014 and this should be maintained at least during the next few quarters. High nominal and – given near-zero inflation – real wage growth, ongoing employment gains, and extremely low interest rates that discourage saving are all factors bolstering consumer spending. For 2016, our current GDP growth forecast is 2.0%, which translates to 2.1% in non-adjusted terms.

Timo Klein Dipl. Volkswirt Senior Economist IHS Economics – Western Europe