German Ifo sounds first note of caution

A first note of caution. German business confidence dropped in May, illustrating that the earlier hard-headed optimism is slightly crumbling. Germany’s most prominent leading indicator, the Ifo index, just decreased to 110.4, from 111.2 in April. Both the current assessment and the expectation component slowed down. Particularly the drop in current assessment component is noteworthy, as it was the first drop after four consecutive increases. The expectation component dropped to 106.2, from 107.3, and now stands at its lowest level since October 2013. The absolute level of the Ifo index is still high and no reason to panic. However, today’s drop combined with the earlier drop in the ZEW index and the PMI manufacturing confirms our view of an upcoming slowing of the economy. Earlier today, the statistical office confirmed the impressive growth comeback of the German economy in the first quarter of 2014. The economy grew by 0.8% QoQ, from 0.4% QoQ in the last quarter of 2013. In fact, the GDP components show that the German economy is already in the midst of a significant rebalancing as growth in the first quarter was exclusively driven by domestic factors. Private consumption was up by 0.7% and investments – to a large extent due to the positive impact of the mild winter weather on the construction sector – accelerated by 7.4% QoQ. Net exports actually shaved off 0.9%-points of GDP growth. Since the beginning of 2011, private consumption has actually outperformed net exports as the growth engine of the German economy. While private consumption has on average contributed 0.2%-points to GDP growth each quarter, the average growth contribution of net exports has been zero. So much for the criticism of an economy that is too dependent on exports. However, before getting too excited about the first quarter growth performance, the rebalancing and the prospects for the coming months, it’s time to sound a note of caution. Since late-2012, the Ifo index has had a mixed performance tracking German GDP growth. It is still very good in tracking the trend of the economy but not the level. Moreover, there are a couple of arguments in favour of a growth correction in the second quarter: the reversal of favourable one-off’s from the first quarter (ie the strong growth contribution of inventories in Q1 and the mild winter weather) as well as increasing headwinds for exports from the East. All in all, today’s data sent two messages: for the time being, the German economy it is still playing in a league of its own; at least in the Eurozone. Unfortunately, as a prominent German soccer team experienced recently, no economy and no soccer team is invincible forever.