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Surprise Increase in Expectations Lifts German Ifo Business-Climate Index to New Record in January

The fact that the renewed worsening of the Eurozone debt crisis since November 2010 has not prevented survey participants from becoming more optimistic about the future is encouraging. Notwithstanding the current shift towards domestic sources of growth, exports remain robust too.

Underlying growth momentum will stay well above 2%, and thus potential, in 2011. The supportive background environment of unusually low interest rates and a relatively subdued euro level due to the sovereign debt crisis will stay in place for some time to come.

IHS Global Insight's January interim forecast has predicted that average German economic growth will only moderate from 3.6% in 2010 to 2.7% in 2011 (in calendar-adjusted terms), thus ensuring that the steep drop of -4.7% in 2009 will have unwound by mid-2011.

The Ifo business-climate index continues to go from strength to strength. In January, it increased from 109.8 to 110.3–another all-time high in the history of German post-reunification data (since 1991). The data corroborates the message given by the December purchasing managers’ index (PMI) release, which had shown a significant, orders-led extension of the rebound observed since October. Strikingly, the Ifo sub-index reflecting six-month expectations was the driving force, increasing from 106.8 to 107.8, its highest level since the start of post-unification records. The current conditions sub-index slipped marginally from 112.9 to 112.8, its first slight setback since February 2010 and only its second monthly decline during the last 19 months. Current conditions, therefore, remain moderately below series highs (115.5 in the boom of 2006–07 and 116.5 in January 1991) for now.

Germany's increasing domestic strength is being boosted by interest rates that are much too low for its own economic conditions, and exports are remaining robust, supported by the moderate level of the euro. Assuming global growth momentum does not collapse due to authorities (specifically in China) slamming on the brakes in order to keep inflation in check, German economic growth will stay very robust during 2011.

Domestic demand will increasingly contribute to GDP growth, but exports will continue to provide a solid contribution too, based on the current competitiveness of Germany's manufacturing firms. In January, wholesale and retail trade as recent drivers of economic growth suffered corrective setbacks (chiefly via current conditions in these sectors, rather than expectations). However, a sizeable increase was posted for the manufacturing-sector climate—based on both expectations and current conditions—with a huge, expectation-driven surge posted for construction.

The Ifo institute has commented that capacity utilisation in the manufacturing sector is now above its long-term average and that firms want to increase employment.

The December spike in the retailer climate was unwound in January, as the buoyancy of pre-festive-period sales in 2010 gave way to more normal conditions. The index declined from December’s cyclical high of 24.1 to 14.0, broadly returning to November’s level of 13.3. This matches the topping out of the GfK consumer climate index for January. Expectations unwound part of recent gains, and current conditions shed most of December’s increase. Nevertheless, the underlying trend for the retail sector still points upwards, underpinned by the ongoing improvement in labour-market conditions, and the boost is providing for consumer confidence about job security and the potential for future wage increases.

Fiscal tightening is not a major risk for a setback to Germany's recovery, and this is compensated in any case by ECB monetary policy continuing to be too soft for German economic conditions for quite some time. Germany's recovering labour market will increasingly lend impetus to private consumption, reducing the dependence on exports. At the same time, German exports will remain quite robust for reasons of competitiveness and because of relatively subdued euro levels, the latter being linked to the Eurozone debt crisis. This indirectly boosts Germany’s trade with the non-Eurozone world. Read more at professional.wsj.com

 

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