IHS Global: German Ifo business climate survey reveals delayed negative
response to Brexit in August, separate service-sector results improve
Frankfurt/Main (25.8.16) – In August, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade declined more markedly than in the previous month, falling from 108.3 to 106.2. This appears to be a delayed negative reaction to the UK referendum decision of 23 June to leave the EU. The level of 106.2 nonetheless still exceeds the long-term average of 101.7 by a solid margin and remains somewhat closer to the interim peak of 109.0 seen in November 2015.
Historic extremes are a low of 83.6 in March 2009 in the wake of the Lehman collapse and an all-time peak of 114.3 in November/December 2010. The Ifo index has thus now broadly returned to the interim low observed in February this year (105.9). The sizeable August decline is at odds with the only modest decline of the manufacturing PMI leading indicator in July/August, especially in view of this having peaked in June so that recent PMI levels remain well ahead of those seen during January-May. The Ifo institute comment on the latest data by saying that the German business cycle has “fallen into a summer hole”. In separate interview statements, Ifo point to Brexit as a likely cause due to chemical and automobile sectors showing some of the largest deterioration – sectors that have fairly strong ties to the British market.
Following only modest slippage in July, the expectations component of the Ifo business climate survey declined from 102.1 to 100.1. This means that the bulk of the rebound from an interim low of 99.1 in February to June’s six-month high of 103.1 has now been unwound again, and the latest level has also slipped marginally below the long-term average for expectations of 100.3. Meanwhile, current conditions worsened by the same margin as expectations, their sub-index falling from a 27-month high of 114.8 to 112.8. Nevertheless, the current conditions sub-index thus remains far above its long-term average of 103.2. It should also be remembered that the most recent downward correction of some length (during April-October 2014) only extended to 108.3, never even getting close to its long-term average. Conversely, however, the all-time record of 121.9 seen in June 2011 is not in danger any time soon now, prevented by particularly high levels of international political uncertainty (including the Brexit and recent events in Turkey).
Conspicuously, today’s separate Ifo survey release about the climate in the service sector – a series available since January 2005 – shows opposite developments to those in goods production and trade. Thus the headline indicator improved for the third consecutive month from 27.7 to 29.5, a level only exceeded in the near-12-year history of the index for a few months during the second half of 2015 (all-time high of 34.6 in December 2015). Unlike contrasting developments between current conditions and expectations in July, both components improved in August. Thus current conditions recovered from 36.4 to 37.1 and expectations posted their third increase in succession from 19.3 to an eight-month high of 22.1. The latter had reached an all-time peak of 26.3 in November 2015 before weakening to an interim low of 13.1 in March. Current conditions, which had deteriorated by a much more limited amount in early 2016 (from 45.2 in December to 37.2 in March), are now essentially back at their March level. Expectations and current conditions both remain well above their long-term averages of 11.2 and 23.7, respectively. The bigger picture reveals that the overall service-sector index initially unwound the break-out to the upside observed in the second half of 2015 during Q1 2016, but has now started to recover anew in recent months. During the almost twelve years of history of this service sector series, expectations have fluctuated between -25.5 (December 2008) and 26.3 (November 2015), and current conditions between -12.4 (May 2009) and 45.7 (September 2015).
Meanwhile, the breakdown of the main Ifo survey by sector, relating to goods production and trade, reveals that only construction managed to avoid deterioration, remaining unchanged from July at a post-unification all-time high. The largest decline in business sentiment was observed in the retail sector (driven by the food industry), followed by wholesale trade and manufacturing. All individual sub-indices reflecting current conditions and expectations posted declines, with the sole exception of construction sector expectations. With respect to the extent of the worsening of expectations, the manufacturing sector was hit much less than both wholesale and retail trade in August. This argues against the notion that exports are becoming a particularly large drag on the economy during the third quarter. The weakening of the retail sector climate represents the biggest surprise in view of the persistently favourable real income background, suggesting that forthcoming September data may well show an upward correction.
Overall, the August Ifo business climate report reveals a delayed reaction to the uncertainty spike caused by Brexit. That being said, PMI data suggest that manufacturing exports are not being hit all too severely, which is not that surprising in view of the long transition phase (at least into 2019) before the UK’s trade relationship with the EU actually changes. German firms will be hoping that most of the UK’s access to the common market will be preserved in the end. Furthermore, Germany’s current economic upswing is in any case more domestically driven these days (construction, private consumption, equipment spending). The concurrent increase in Ifo’s service-sector survey ties in with this view, which suggests that the weakness in domestic demand revealed by yesterday’s Q2 GDP release will prove a temporary affair. Meanwhile, the near-term impact of the refugee crisis on the economy will remain positive, as government consumption and investment is being raised, enabled by budget surpluses.
The August IHS forecasts for (calendar-adjusted) GDP growth in 2016 and 2017 have been raised from temporarily more depressed levels as the near-term Brexit impact is turning out to be less severe than feared – as is already being signalled by newly rebounding PMI and ZEW leading indicators. We are currently predicting growth of 1.8% in 2016 and 1.7% in 2017, both higher than the pace of 1.5% in 2015.
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