Today’s leading indicators have added clear evidence that recessionary risks in the German economy are increasing. The Ifo index continued its recent downward trend in October, dropping to 100, from 101.4 in September. This is the sixth consecutive drop, bringing the Ifo index to its lowest level since February 2010. The drop was driven by a sharp deterioration of the current assessment component which dropped to 107.3, from 110.3. Earlier today, the PMIs painted a similar dire picture with the PMI manufacturing dropping to 45.7, from 47.4. The only upside in today’s Ifo report was that the expectation component remained unchanged.
The soft landing of the German economy continues. The sharp drop in the current assessment component shows that the good times are, at least for now, over. The industry’s safety net has become very fragile. Order books have become significantly thinner over the last months and orders at hand are currently as low as in October 2010. At the same time, companies have increased their inventories. A combination which clearly does not bode well for industrial production in the coming months.
The slowdown of the German economy is not only a consequence of the euro crisis but also of the global economic cooling. In fact, at least German exporters have started to decouple from the rest of the Eurozone. Over the last four years, the share of Eurozone countries in total German exports has dropped from around 43% to roughly 36%. Currently, Germany exports more to China than to Ireland, Greece, Portugal and Spain together. As long as the main economic blocs outside Europe can pick up steam again, Germany should be able to escape the current fate of most of its Eurozone peers.
With the ongoing slowdown, calls for fiscal stimulus are likely to become louder again. Not only for the sake of Eurozone rebalancing but also to support the German economy. Chancellor Merkel has not entirely ruled out additional stimulus. However, with the constitutional debt brake starting in 2016 and probable tensions within the government on how to spend it, any new stimulus should remain very limited. The tax cuts decided last year, amounting to roughly 0.1% GDP in both 2012 and 2013, illustrated the government’s preference for austerity rather than stimulus.
All in all, today’s Ifo index calls for a somewhat nuanced interpretation. The sharp drop in the current assessment component is a clear sign that the economy has entered contraction territory. Stabilised expectations, however, give hope that any contraction will not feel like a recession.