Friday, May 22, 2015

Ifo drops only marginally in May

German macro morning, part 2. The future. German business confidence only gave in marginally, illustrating almost imperturbable optimism. Contrary to this week’s ZEW and PMI readings, Germany's most prominent leading indicator, the Ifo index, remained almost unchanged, dropping to 108.5 in May, from 108.6 in April. While the current assessment component improved to its highest level since May last year, expectations dropped to 103.0, from 103.5 in April. With today’s GDP data, yesterday’s PMIs and now the Ifo, new doubts about the strength of the German economy could emerge again. In our view, any of these swan songs on the German economy are premature. However, it is simply a fact that Germany is at the end of a very positive reform-growth cycle, which is artificially extended by external tailwinds. In addition, given the long recovery the German economy has already gone through, it is only more than normal that growth rates at some point in time will be lower than in the rest of the Eurozone, which in turn has been suffering from weak growth now for several years. In the short run, the fundamentals are sound enough to see another acceleration of the German economy. This is also reflected in today’s increase in the Ifo’s current assessment component. As orders at hand have increased again and inventories have dropped, industrial production should support growth in the coming months. Moreover, and probably even more important, the strong labour market, higher wages and low interest rates should further drive consumption and the construction sector. Finally, the weaker euro should continue to boost German exports. However, despite these sound fundamentals, some volatility might lay ahead. As public holidays and bridge days could reduce working days in May to a possibly record-breaking low of 17 days, some data distortion should be expected. Looking ahead, and despite our optimistic outlook for the German economy, there are several risks, grouped into short- and long-term risks. In the short run, the in our view most important risks are: i) the never-ending Greek crisis, which despite latest rumors of some progress could still escalate and is clearly more dangerous and explosive than financial market participants seem to believe; ii) a longer-than-expected period of weakness of the US economy, which could affect German exports both through less demand and a further strengthening of the euro; and iii) a further escalation of what seems to be a new strike culture in Germany. Up to now, the economic impact from several strikes this year should have been very limited. But this could change. In the longer run, the lack of new reforms to further reduce unemployment, the current investment gap and the deficit in digitalization could eventually backfire on the German economy once the current favourable tailwinds like the weak euro, low energy prices and interest rates disappear. All in all, today’s German macro morning was clearly not enough to cheer up real morning grumps. However, this morning’s data were also no reason to stay in bed and get depressed about the German economy. Maybe the economy is just human: it can’t deliver peak performances every month or every quarter.

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