November Ifo beats estimates

An island of happiness after all? German businesses showed an interesting reaction to the recent series of uncertainties and turmoil. In fact, despite not so positive hard data and new uncertainties stemming from the refugee influx and latest events in Paris, German businesses remain a bunch of optimists. Germany’s most prominent leading indicator, the just released Ifo index, increased to 109.0 in November, from 108.2 in October, offsetting last month’s drop. Interestingly, both the current assessment and the expectations component increased. In fact, expectations increased to their highest level since May last year. Today’s Ifo reading suggests that the German business community is filing the Volkswagen scandal as a one-off and also shrugs off the risk from a possible Chinese and emerging markets slowdown as well as new uncertainty stemming from the Paris events. Still, the positive Ifo reading is a bit of a conundrum as it is not entirely matched by positive hard data. In our view, hard data since the start of the year showed that the German industry is actually going through rough times. Latest industrial production data suggested that the summer slump was more than only vacation-driven. In fact, the industry has underperformed since the beginning of the year, being confronted with several external headwinds. Currently, an additional headwind could be low, or better too low, oil prices. While low oil prices are clearly not only benefitting German consumers but also producers by lowering production costs, the current question is whether oil prices have actually dropped too far, hurting demand from for German products from oil-exporting countries. This phenomenon of oil bill recycling, ie stronger demand from oil-exporting countries, in the past shielded the German industry against higher oil prices. Looking ahead, latest survey data send opposing signals. While latest PMI and Ifo data give rise to new optimism, the combination of inventory build-up and dropping new orders has clearly weakened the normally strong safety net for the German industry. Moreover, the facts that capacity utilization remains close to its historical average and companies do hardly see equipment as a constraint to production suggest that a self-driven investment spurt is currently not in the cards. It will take some more weeks before the final verdict can be made on which survey indicator actually is the best growth predictor. Currently, markets are not only watching German data to get insights on the German economy but also to get an idea of what the ECB can and will do at next week’s meeting. While stronger-than-expected confidence indicators could motivate some ECB members to pitch the old Prince song “When doves cry” and argue against new ECB action, Draghi’s determination at the October meeting combined with continued underlying economic weaknesses and the absence of any inflationary pressure should be decisive in launching QE2.