Unstoppable optimism?

Is sky the limit? German business optimism seems to be unstoppable, paving the road for an excellent growth year 2015. Germany's most prominent leading indicator, the Ifo index, just increased for the sixth month in a row to 108.6 in April, from 107.9 in March. While the current assessment component improved to 113.9, its highest level since June last year, expectations weakened somewhat to 103.5, from 103.9 in March. The German economy is in good shape. The first months of the year point to a good, though not excellent, growth performance in the first quarter and the next quarters should not be very different. In fact, Germany remains the biggest beneficiary of the euro crisis and the ECB’s QE. Even if the weak euro has not yet entirely found its way to strong export numbers, at some point in time it should. Moreover, strong domestic demand on the back of record high employment, wage increases, low energy prices and a new appetite for consumption, driven by record low interest rates, has become an important growth driver for the German economy. Yesterday’s GfK index confirmed the picture of almost euphoric consumers. At 10.1, the index is now at its highest level since October 2001. However, before becoming too lyrical about the German economy and jumping on the bandwagon of upwardly revised growth forecasts, a brief glance at today’s expectation component and yesterday’s PMIs justifies some caution. Particularly the Greek crisis but also an unexpected longer-than-expected soft spell of the US economy and a further weakening of the Chinese economy provide reasons enough to be optimistic, but not lyrically overoptimistic. Carsten Brzeski

ECB meeting - Unexpected excitment in Frankfurt

What everyone had expected to be a rather dull press conference will go down in history as an unforgettable meeting. Not so much due to new monetary policy action or insights but due to a female protester storming on top of ECB president Draghi’s desk, spraying confetti on him and shouting about the end of “ECB dictatorship”. Luckily, no one was harmed and the woman was quickly hauled away. A stalwart Draghi continued with the press conference just a few minutes later. The rest of the press conference could hardly match the excitement of the first minutes. As expected, the ECB kept interest rates unchanged. While the ECB’s macro assessment was somewhat more positive than at the ECB’s March meeting, not a lot has changed. Draghi’s main goal today was obviously to downplay any premature tapering speculations. And, he accomplished his mission. At least for now. As regards the ECB’s macro-economic assessment, Draghi stressed the prospects for a Eurozone recovery on the back of improved domestic demand, lower oil prices, the weaker euro and also structural reforms. Draghi also pointed to still existing risks to the recovery but the most notable change in the assessment was a slight change to the risk assessment. According to the ECB, risks to the outlook are still to the downside but now “more balanced” than in March. As regards inflation, the ECB kept the same assessment as in March, which is a very gradual increase in headline inflation over the next two years. More specifically on QE, Draghi repeated that monetary policy alone could not carry the economic recovery. Governments needed to continue with structural reforms. Addressing earlier criticism, Draghi said that QE did not prevent governments from implementing reforms but was rather conducive for reforms. Asked about possible side-effects from QE, Draghi acknowledged that a protracted period of low interest rates could lead to imbalances but he did not yet see any bubbles in the Eurozone. With many government bond yields currently trading in negative territory, we indeed are curious to learn more about Draghi’s definition of bubbles. In the days leading to today’s meeting, some market participants had started to discuss the possibility of an early tapering, an end of QE earlier than the officially intended deadline of September 2016. One reason for this discussion is actually the success of QE which has pushed down the euro exchange rate. At its current level, the weak euro would mechanically add another 0.4%-points to inflation, bringing headline inflation above 2% in 2017. This could already happen at the June meeting, when the ECB will present the next staff projections. During the press conference, Draghi tried everything he could to temper the taper discussion. According to Draghi, the tapering discussion was premature. And we totally agree with him. Draghi did not get tired of repeating that the full implementation of QE was required to “provide the necessary support to the euro area recovery”. Moreover, a new sentence in the ECB’s introductory statement clearly tried to temper tapering phantasies: “When carrying out its assessment, the Governing Council will follow its monetary policy strategy and concentrate on trends in inflation, looking through unexpected outcomes in measured inflation in either direction if judged to be transient and to have no implication for the medium-term outlook for price stability” In our view, this sentence is just ECB language for saying that the ECB can do whatever it wants and use whatever indicator it wants to use to determine the end of QE. All in all, ECB president Draghi clearly tried to temper any taper discussion. Whether he will succeed, is uncertain. If the recovery really unfolds and inflation forecasts start to pick up, Draghi will not only have to temper taper speculations in the market but, even more challenging, within the ECB itself.

German economy not at full speed (yet)

Bag of mixed data. German industrial production struggled to gain further momentum in February, increasing by only 0.2% MoM. The 0.6% increase in January was revised downwards to a drop by 0.4% MoM. On the year, industrial production is down by 0.3%. The meagre increase in industrial production is mainly the result of a reversal of weather-related strong activity in the construction sector in January. The increase of activity in manufacturing (0.5% MoM) and capital goods (1.2% MoM) shows that the German industry has currently more momentum than suggested by headline numbers. At the same time, the statistical office also released latest trade data. Exports increased by 1.5% MoM in February, from a 2.1% drop in January. As imports increased by 1.8% MoM, the seasonally-adusted trade balance remained unchanged at 19.6 bn euro. Today’s trade data will do little to hush the international dispute on Germany’s high current account surplus. The country’s trade balance is moving from one record high to another. While the criticism of too few domestic investments is clearly justified, it is useful to remember that – at least in the German economy – external and internal activities have hardly ever been two sides of the same coin. It is far from uncertain that more domestic activity, be it consumption or investment, would automatically lead to a significant reduction of the trade surplus. In fact, last year’s growth performance already showed that solid domestic demand can go hand in hand with net export growth. Despite ongoing geopolitical tensions and Eurozone weakness, net exports contributed positively to German growth in three out of four quarters last year, while at the same time, private consumption grew at more than double the pace of the fifteen years before. Looking ahead, both the domestic and the external part of the German economy look set for further improvement. On the back of record high employment, low unemployment, higher wages, low interest rates and low inflation, private consumption should gain further momentum. At the same time, confidence indicators and order books send encouraging signals for growth of industrial production in the coming months, even after yesterday’s rather disappointing new orders data. Only the fact that inventories have remained unchanged in recent months provides some note of caution. The most encouraging signal, for the German industry comes from the weaker euro. Judging from earlier episodes with similar exchange rate weakness, order books are currently only moderately filled. If past performances are any guide for the future, German exporters can start rubbing their hands. Today’s data are good but not as good as buoyant confidence indicators had suggested in recent weeks. At its current level, industrial production only points to meagre growth in the first quarter. However, as there is still more good news in the pipeline, there is no need to doubt the Spring revival of the German economy (yet).

German new orders drop in February

Unexpected disappointment. German new orders dropped unexpectedly in February, indicating that the Eurozone’s largest economy is still not an isolated economic island. New orders decreased by 0.9% MoM, from an upwardly revised -2.6% in January. On the year, new orders are now down by 1.3%. It is the first time new orders dropped in two consecutive months since June 2014. Interestingly, the drop was only driven by the lack of foreign demand. New orders from Eurozone peers dropped by 2.1% MoM, from -4.9% in January, showing that the positive mood in the rest of the Eurozone has not yet led to better hard data. To some extent, disappointing German new orders data tell more about the state of the Eurozone economy than about the German economy. The German industry has left the soft spell of last summer finally behind. Despite today’s drop, order books are filled again. However, compared with the start of last year, the industry is still treading water. In fact, new orders, both domestic and foreign, are currently only back at their respective levels from early 2014. Looking ahead, confidence indicators and order books send encouraging signals for growth of industrial production in the coming months. Only the fact that inventories have remained unchanged in recent months provides some note of caution. The most encouraging signal, for the German industry comes from the weaker euro. Judging from earlier episodes with similar exchange rate weakness, order books are currently only moderately filled. If past performances are any guide for the future, German exporters can start rubbing their hands. All in all, there is no need to worry. However, today’s drop in new orders shows that after a series of almost euphoric news and indicators from Germany and Eurozone, some caution is clearly justified.