Thursday, December 18, 2014

Ifo signals conciliatory year-end

Conciliatory year-end. German business confidence confirmed the decent rebound of the economy in the final quarter of the year. Germany's most prominent leading indicator, the Ifo index, just increased for the second month in a row to 105.5 in December, from 104.7 in November. While the current assessment component remained unchanged, expectations increased to 101.1, from 99.7 in November. A rather disappointing year for the German economy comes to an end. The impressive growth performance of the first quarter was more than offset by a subsequent soft spell, which took longer than expected. The former growth miracle had quickly lost its glamour. With an average quarterly growth rate of 0.2% since early 2013, the German economy has morphed almost unnoticed from the Eurozone’s splendid growth engine to one-eyed in the land of the blind. In recent weeks, some of the worst concerns have subsided, though not disappeared. The Ukraine-crisis has calmed down, without being solved; the rest of the Eurozone should continue to recover, albeit at a too low pace; and the negative impact from the timing of the summer vacation has finally disappeared. Even better, lower energy prices and the weaker euro should make a decent short-term stimulus package for the German economy. As experienced in the past, the German economy is one of main beneficiaries from lower energy prices and a weaker exchange rate. Over the last twenty years, German exports to non-Eurozone countries have shown a rather unique correlation with exchange rate movements. Relatively immune against currency strengthening but strongly benefitting from currency weakening. A lucky pattern not all Eurozone countries have experienced. This positive effect should start to kick in in the coming months. Moreover, lower energy prices have already boosted every German’s disposable income by 25 euro per German. Last but not least, the fact that next year several public holidays will fall on weekends should add some 0.2%-points to GDP growth. Currently, probably the two biggest downside risks to a rosier German near-term outlook are Russia and complacency. As regards Russia, German exports to Russia have already suffered under the sanctions and the Russian slowdown, currently standing 22% below last year’s level. The current ruble crisis should now have a broader impact on German exporters as it should also affect products that did not yet fall under the sanctions. Even if Russia currently only accounts for roughly 2.5% of all German exports, direct and indirect repercussions from the current ruble crisis cannot be excluded. As regards the second risk, a recovery on the back of an external stimulus package also bears the risk of further self-complacency and a resistance to start new reforms. This year’s weakness provided further evidence that the economy is still too dependent on exports. Despite running at full employment and an almost closed output gap, private consumption has not been able to give a strong boost to the economy. Private consumption’s annual average growth rate between 2010 and 2014 almost doubled that of 2005-2009. However, at only 1% it was good but not good enough. The same holds for investment. With some slight upward momentum this year, it is still far too weak to close the gap with investment in most other developed economies, which widened between 1995 and 2009 when domestic investments grew by only 0.1% per year. There clearly is enough room for improvement. All in all, today’s Ifo reading gives a conciliatory end to an exciting but also disappointing year of the German economy. The economy once again defied premature swan songs. It’s now time to take a deep breath and enjoy Christmas, even if there is no reason for excessive backslapping.

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