Monday, July 27, 2015

German Ifo defies Greek woes

Forget about Greece. This is at least how German businesses seem to look at Greek turbulences of the last weeks, judging from the latest Ifo numbers. Germany’s most prominent leading indicator just increased to 108.0, from 107.4 in June. Both the current assessment and the expectations component increased, with the current assessment component almost returning to its May level. In the eyes of German businesses, the external tailwinds, stemming from low energy prices and a weak euro, clearly outweigh any downside risk from the Greek crisis on the German economy. Even if the doses has been reduced somewhat, the German economy is still on steroids. Despite some recent rebounds, the weak euro exchange rate and low energy prices are still artificially extending the last phase of a very positive reform-growth cycle. Even after today’s drop, the level of the Ifo remains comfortably high. In fact, comparing the levels of the second quarter with the levels of the first quarter suggests a growth acceleration of the German economy in Q2, confirming our positive growth outlook. Looking beyond the second quarter, the German economy currently faces three major risks: : i) the never-ending Greek crisis, which despite latest positive developments is still far from being solved and could re-escalate quickly almost any time; ii) a longer-than-expected periods of weakness of the US and the Chinese economy (both accounting for 15% of total German trade); and iii) the lack of new reforms to further reduce unemployment and tackle the current investment gap combined with the deficit in digitalization could eventually backfire on the German economy once the current favourable tailwinds disappear. While there is little German policymakers can do to tackle the first two risks, developments in domestic sectors can be influenced. A closer look at the German industry shows that the industrial safety net has become somewhat thinner over the last months. Orders at hand have slightly come down and inventories have remained relatively stable at moderate levels for more than half a year now. This suggests that not too much production acceleration is currently in the German industry’s pipelines. Interestingly, capacity utilisation in the German manufacturing sector is still lower than in 2011 and 2012. Even though financing conditions in Germany remain extremely favourable, average capacity utilisation rates, modestly filled order books and continued uncertainty in main export destinations all argue against an imminent investment boom. In fact, financing conditions are currently so favourable that they might even trigger “economically useless” investments. In our view, the only way out of this dilemma would be government-induced or supported investments in typical public goods, eg infrastructure, energy and education. Last month, Grexit fears were discussion topic number one on German streets, pubs and even boardrooms. With latest developments in the Greek crisis and the agreement to reach a deal, discussions in local pubs can focus again on the upcoming soccer season and, as today’s Ifo index suggests, companies want to return to business as usual.

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