German Ifo defies market and China woes

Just a transitional snapshot or a sign of absolute matter-of-factness? German companies remain unimpressed by the current series of uncertainties and turmoil. Neither the Greek crisis nor the new Chinese uncertainties and stock market turbulences have been able to dent German business’ optimism. Germany’s most prominent leading indicator, the just released Ifo index, increased to 108.3 in August, from 108.0 in July. While the current assessment component increased to its highest level since April 2014, the expectation component dropped marginally to 102.2, from 102.3 in July. There are two possible explanations for today’s surprise increase. Either the ongoing stock market turbulences came simply too late to have an impact on the Ifo survey and will therefore only unfold their full negative impact next month, or German businesses are a bunch of ice-cold realists, sticking to the pure facts. In our view, there are many arguments in favour of the latter. And, indeed, the pure facts clearly argue against panic. First of all, as illustrated by this morning’s second estimate of 2Q GDP data, the German economic model has become much more balanced than critics have been complaining about. GDP growth was confirmed at 0.4% QoQ, mainly driven by both net exports and consumption. At the same time, inventories and investment turned out to be a drag on growth. The bigger picture shows that over the last quarters, private consumption has been a stronger growth driver than net exports. While net exports contributed less than 0.2 percentage points to quarterly GDP growth rates, private consumption accounted for 0.3 percentage points. The renewed drop in energy prices should clearly support domestic demand in the months ahead. Secondly, a slowdown of the Chinese economy is not the same as a recession. After years of strong growth, it is somewhat normal that growth rates are coming down. Let’s not forget that at the current growth rate, the Chinese economy would still add the size of the Swiss economy every year. Thirdly, German exports to China have already slowed down in the first half of the year, without derailing the German recovery. The geographical diversification of German exporters should cushion any further weakening of Chinese demand. China currently accounts for less than 6% of total German exports. As long as other major export markets like the US, the UK, Eastern Europe and the Eurozone are continuing to grow or at least avoid a new slowdown, German exports should remain solid. Fourthly, the devaluation of the Chinese renminbi alone should not automatically crowd out German products. To the contrary, over the last five years, German exports to China had recorded growth rates of between 20% and 60%, with an exchange rate much stronger than currently. Last but not least, latest stock market turbulences, Chinese uncertainties and a marginally strengthening of the euro exchange rate have gone hand in hand with a sharp drop in commodity prices. This drop in commodity and energy prices is in our view the final argument against any panic as it should support domestic demand. All in all, it is obviously too early to give the final verdict on the economic fallout of the latest market turmoil and Chinese uncertainties. German businesses, however, are taking a rather benign stance, putting their money on the fundamental strengths of the German economy.