Thursday, November 24, 2011

Ifo surprises in November

Last crisis antagonist? Today’s Ifo index illustrates that German crisis resistance is stronger than expected. In November, the Ifo index increased surprisingly to 106.6, from 106.4. While the current assessment remained unchanged from October, expectations rebounded to 97.3, from last month’s 97. Particularly the small increase of the expectations component bodes well for our main scenario that the German economy is not falling off a cliff.

The Ifo increase comes after a longer period of market worries about the strength of the German economy. In fact, with yesterday’s disappointing bond auction, some market participants already welcomed Germany in the debt crisis club. The lack of investor’s appetite for German government bonds was by some market participants even considered as a vote of no confidence against Germany. Time to put things into perspective.

Without any doubt, the German economy is cooling off. Most confidence indicators are pointing southwards. And indeed, there are at least three major risks for the German economy in the coming months. Obviously, the Eurozone debt crisis comes in at top of potential risks. With bigger trading partners having to engage in austerity measures, external demand looks set to weaken. Don’t forget that France is Germany’s single most important trading partner, accounting for roughly 10% of all German exports. Second, a further drop in sentiment, particularly by just recently awakened consumers, could lead to a significant loss of momentum. Finally, bank recapitalisations and restructurings could lead to a credit crunch in the coming months.

However, on a more positive note, even after yesterday’s bond auction, absolute rate levels are historically low, the absolute levels of most confidence indicators is still above recessionary levels, a further stabilization of the US economy could at least to some extent offset weakening Eurozone demand and latest lending data show do not confirm any credit crunch concerns, yet. In fact, credit to the private sector has actually increased over the last couple of months. Moreover, German companies are benefitting from low interest rates as the high dispersion of bond yields across the Eurozone is also reflected in bank interest rates. Finally, with the strong labour market and high backlogs for companies, economic fundamentals still put a strong safety net under the economy.

The debt crisis has sent the Eurozone economy into recessionary territories. The German economy will not be able to escape these general recessionary tendencies. However, today’s Ifo index shows that if policymakers get a grip on the crisis management, Germany could get off more lightly than most other countries. Thanks to sound fundamentals, any growth slowdown in Germany should feel like a soft patch, rather than recession.

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