IHS: Increase in Germany’s Ifo business climate index to fresh

post-unification record in July contradicts recent setbacks elsewhere

 

Frankfurt/Main (25.7.17) – In July, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade posted a surprise further increase from 115.2 to yet another post-unification and thus post-1990 high of 116.0. This now clearly exceeds the levels seen during the heyday of the post-Lehman recovery of 2010-11 when GDP growth temporarily reached 4% – whereas the growth pace at present is barely above 2%. Germany’s current business climate compares to an interim high of 108.6 just before the UK referendum on Brexit in June 2016, a long-term average of 102.1, and an all-time low of 83.6 in March 2009 in the wake of the Lehman collapse. The extraordinary strength of the latest Ifo data stands in marked contrast to downward corrections in July of other leading indicators such as the PMI and ZEW data. The Ifo institute comment on the latest data by saying that “German businesses are euphoric” and that “the German economy is at full steam”.

 

The expectations component increased from 106.8 to 107.3, its highest level since February 2014 and well above its long-term average of 100.5. Current conditions increased by an even larger margin from 124.2 (revised up from 124.1) to a new all-time peak of 125.4. The previous record had been set in mid-2011 at 121.7 in the context of the post-Lehman recovery. Note that the last time that the current conditions index has been below the present long-term average of 103.8 was more than seven years ago, and the last downward correction of some length (April-October 2014) bottomed at 108.4. It appears that the high degree of international political uncertainty during the past year, which in part remains ongoing with respect for instance to Brexit negotiations and US developments, no longer weighs down on German business optimism. The same holds for the euro’s appreciation of recent weeks. At the same time, the encouraging outcome of the recent French presidential and parliamentary elections (with a view to reform and thus long-term European growth prospects) remains a supportive factor for the general European economic environment.

 

Note that the release of the separate Ifo survey about the climate in the service sector – a series available since January 2005 – will now always be a day after the release about conditions in industry, construction, and wholesale and retail trade described above. In June, the services survey index (released on 27 June) had remained broadly stable for the second consecutive month, having declined between December 2016 and April. Following an all-time high of 35.5 in November 2016, the headline index slipped just slightly from 26.2 (revised up from 26.0) to 25.8. These service-sector data thus continue to underperform versus the business climate in industry, construction, and wholesale and retail trade. Services expectations did improve for the second month in succession, however, increasing from 12.9 to 13.9 (which exceeds its long-term average of 11.6). Expectations had reached an interim peak of 24.4 in October 2016 and an all-time high of 25.8 in November 2015. By contrast, current conditions in the service sector fell anew from May’s 40.3 to 38.4. Following outperformance versus expectations previously, the gap of current conditions with their all-time high (47.9 in November 2016) is now at a similar magnitude, but current conditions remain further above their long-term average (25.0). The development of the last two years 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, then rebounded anew to a record level in November 2016, but has since encountered a fresh setback. During the twelve-and-a-half years of history of this service sector series, expectations have fluctuated between -25.9 (December 2008) and 25.8 (November 2015), and current conditions between -12.8 (May 2009) and 47.9 (November 2016).

 

Meanwhile, the breakdown of the main Ifo survey by sector, relating to goods production and trade, reveals improvements in all sectors but retail – noting that the latter had shown the strongest performance in the previous month. Optimism in manufacturing, which has been enjoying a fresh upswing since February, increased by a solid margin to a new record level. Although driven by a fresh all-time high of current conditions, expectations also improved to their best level since early 2014. The Ifo institute has highlighted that capacity utilization has increased markedly by 0.7 points to 86.7%. Construction sentiment rebounded after June’s marginal one-off setback, also reaching a new record high (since the start of pan-German data in 1991). In contrast to manufacturing, this was driven by improving expectations, while current conditions remained broadly steady near its all-time high. Meanwhile, business climate in the wholesale sector improved for the fourth consecutive month, propelled by expectations while current conditions retreated slightly from June’s record high. Finally, retail sector sentiment, which had improved markedly to its highest level since early 2014 in June, roughly declined back to the level seen in May. This owed to both current conditions and expectations in equal measure.

 

Overall, July’s strong Ifo business climate report contrasts with the downward corrections seen for PMI and ZEW leading indicators at the data edge in July. That being said, the export orders component of the PMI survey had shown an increase against that survey’s general trend, which is consistent with improving manufacturing sector sentiment as demonstrated by the latest Ifo data. The Ifo institute has pointed out that the strengthening euro of recent weeks has not really impeded the latest improvement in sentiment. As before, construction remains structurally supported by factors such as demographics and persistently low interest rates, and retailer climate remains at historically elevated levels despite the setback in July. This is underpinned by the fact that the climate in the services sector has steadied in May-June following slippage in early 2017.

 

Having been raised modestly already in May, the July IHS Markit forecast for (calendar-adjusted) GDP growth in 2017 and 2018 has been left at 2.0% each. Near-term underlying growth momentum is even around 0.6% q/q (thus close to 2.5% annualized), but it should be kept in mind that a recoil effect affecting construction output after the mild winter is likely to restrain second-quarter growth to 0.5% q/q. Improved European growth prospects following political developments in France (election of Emmanuel Macron as president and absolute majority for him in parliament, opening up reform potential) will be supportive also for Germany’s economy in the months ahead. Potentially disruptive developments linked to the Brexit negotiations and possible protectionist measures by the Trump administration in the US offset this only in part.

Best regards, Timo Klein Principal Economist | IHS Markit Economics