Wednesday, December 19, 2012

Ifo adds to evidence of green shoots in the winter

The year ends on a positive note. Germany’s most prominent leading indicator, the Ifo index, increased in December for the second month in a row and stands now at 102.4; its highest level since July. While the current assessment component dropped to its lowest level since June 2010, the expectation component increased for the second consecutive month. In fact, expectations recorded the strongest monthly increase since July 2010.

The German economy is still in the course of its soft landing. With the sharp drop of industrial production and the narrowing of the trade surplus in October, a contraction of the economy in the fourth quarter has become almost inevitable. It is hard to believe that private consumption, particularly Christmas shopping (which in Germany actually almost always disappoints, after hopeful expectations), can be strong enough to offset weaker exports and industrial activity

However, looking into 2013. the biggest trump card the German economy holds is the gradual decoupling from the rest of the Eurozone throughout the crisis. The decoupling can be identified in several areas. First of all, and the most obvious, is the shift of exports from Eurozone countries towards non-Eurozone countries. Over the last years, the share of German exports to other Eurozone countries has continuously dropped from almost 45% in 2008 to roughly 35% this year. This enables the economy to benefit quickly from any rebound of the global economy and leave Eurozone worries behind. Secondly, the reforms of the early 2000s and the lack of qualified workers due to ageing have decoupled the labour market from its Eurozone peers. Currently, less growth is needed to create jobs. Thirdly, the investment cycle could be the next area of decoupling. In 2012, investment had been the strongest disappointment of the economy. However, with a pick-up in global activity, capacity utilisation should increase again, bringing back earlier investment plans which had been shelved due to increased uncertainty. As German companies can still benefit from record low interest rates, investment could be the next element of German decoupling from the rest of the Eurozone. Sound fundamentals and the gradual decoupling from the rest of the Eurozone offer a solid warranty for a quick rebound.

With a worsening current assessment but improving expectations, today’s Ifo sends a clear message: things will go worse before they get better. It looks as if any contraction of the economy should be short-lived.

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