German Ifo increases in January

Good news from the perfect little world. German business confidence confirmed the decent rebound of the economy in the final quarter of the year. Germany's most prominent leading indicator, the Ifo index, just increased for the third month in a row to 106.7 in January, from 105.5 in December. While the current assessment component improved to 111.7, from 110.0, expectations increased to 102, from 101.1 in December. The rollercoaster ride of German economic data could still last for a while. The conciliatory end of the year 2014, with an estimated annual growth rate of 1.5%, could take turns with rather disappointing December data. Let’s not forget that December was yet another month, strongly affected by the timing of vacation. Luckily, the year 2015 should be less sensitive to seasonal fluctuations. Looking ahead, the German economy should enjoy a pleasant tail wind, stemming from lower energy prices, the weaker euro and rock-bottom interest rates. Over the last twenty years, German exports to non-Eurozone countries have shown a rather unique correlation with exchange rate movements. Relatively immune against currency strengthening but strongly benefitting from currency weakening. Another boost for the German economy on the back of the ECB’s QE is one of the ironies of the Eurozone. The country with the most outspoken criticism could be the biggest beneficiary. Unless German ECB critics had in mind that a recovery on the back of an external stimulus package bears the risk of further self-complacency and a resistance to start new reforms. All in all, almost everything is put in place for another strong year of the German economy. At least in a little perfect and linear world. However, the aftermath of the Greek elections will show that perfect and linear worlds do not exist. As first German official reactions to the Greek election results this morning have shown, maybe the biggest challenge for at least German policymakers in the short run.

Mario Draghi's latest (and last) stunt?

Today, the ECB finally entered the global QE arena. Instead of keeping some aces up their sleeves, the ECB showed its entire hand: a fully-fledged QE programme with exact numbers; a €1.1 trillion quantitative easing programme to boost the economy. At least when it comes to the precision and details already presented today, the programme is bolder than expected. The arguments supporting the QE decision have been known already for a long while. Low inflation expectations, negative inflation rates, disappointing results from earlier liquidity and credit-enhancing measures and an overall bleak outlook for growth are convincing arguments for the ECB to act again. According to the ECB today, additional asset purchases are needed to counter two unfavourable developments: weaker-than-expected inflation dynamics and heightened risks of a too prolonged period of low inflation. As regards the details, the ECB announced to expand the current asset purchase programme (of ABS and covered bonds) by including government bonds. For the first time, the ECB also presented a monthly target for its purchases. As of March, the ECB will start purchasing “euro-denominated investment-grade securities issued by euro area governments and agencies and European institutions in the secondary markets”. Or in short, government bonds and supranational bonds. The ECB’s purchases will be based on the national central banks’ shares in the ECB’s capital key and the ECB plans to buy government bonds with maturities between two and 30 years. However, according to Draghi, the ECB purchases will be limited to 33% of each issuer. The statement that “some additional eligibility criteria will be applied in the case of countries under an EU/IMF adjustment programme” means that the ECB could also by Greek bonds, at least as long Greece stays in a bailout programme. Moreover, the ECB also announced to scrap the 10 basis point premium on all six remaining TLTROs. With the amount of 60bn euro per month and the intended duration of the programme until the end of September 2016, the ECB could return the size of its balance sheet back to 3 trillion euro. Given the amount of purchased ABS and covered bonds so far, the ECB will indeed have to buy government bonds for at least around 50bn euro. Despite the hard numbers, the ECB’s commitment was at least semi open-ended as Draghi also said that QE would also continue "at least until we see a sustained adjustment to the path of inflation". According to Draghi, the issue of risk-sharing of the purchases was not essential for the effectiveness of monetary policy. Nevertheless, the ECB had to accommodate concerns of some national central banks. As a consequence, only 20% of the purchases will be risk-shared (of which the main part would be supranational bonds), the rest not. The impact of QE in the Eurozone is highly controversial. If there is at least one single inflationary tendency in the Eurozone right now, it is the amount of articles and opinions on the sense and nonsense of QE. Only time will tell which arguments were right or wrong. Obviously, the ECB hopes for an investment boom on the back of QE and even lower interest rates. However, whether ECB purchases of government bonds will really free new lending space at banks or through higher equity prices room for corporate investment is far from certain. Therefore, the safest bet for a positive QE impact seems to be through a weaker euro exchange rate. All in all, it seems that the ECB hopes for a happy end of a long fairy tale of fighting the euro crisis. It all started with measures to keep the Eurozone together and has now led to a series of activity –reviving measures (just think of negative deposit rates, TLTROs, ABS and covered bond purchases). There is no guarantee that QE will work. The ECB can prepare the grounds for more investment and activity but it cannot force consumers to spend or companies to invest. This also requires further structural reforms, fiscal support and probably a longer, positive, vision for the entire Eurozone. Against this background, today’s QE announcement is historic but it was also the ECB’s last trump card. There are no more hidden aces. We have heard it often in the past but the flowery phrase that the ball is now back in the court of Eurozone governments has never been more true than today. Even worse, the ECB will not be able to pick it up again if governments try to play it back.

German economy grew by 1.5% in 2014

It is a strange habit of the German statistical office to release GDP data for the entire past year before actually publishing fourth quarter data. According to the just released numbers, German GDP increased by 1.5% in 2014 (both calendar and non-calendar adjusted), from 0.2% in 2013. In our view, this outcome suggests that the German economy has probably grown by some 0.3% QoQ in the fourth quarter. Moreover, the statistical office also released a first estimate of Germany’s 2014 fiscal balance. While almost the entire rest of the Eurozone is still engaged in austerity policies, German public finances remain strong. According to the statistical office, Germany recorded a fiscal surplus of 0.4% GDP in 2014, leading to a new historic record of posting three consecutive years with a fiscal surplus. German austerity fetishists will love it. With today’s numbers, the economic year 2014 can almost be filed away. It was a very special year in which the German economy sometimes showed characteristics of a small banana republic as it proved unusually sensitive to the weather, the timing of vacation and public holidays. Particularly the curse of vacation could still have some echoing effects on Q4 growth. The Christmas vacation period should have slowed down industrial production significantly in December, making a downward revision of Q4 numbers likely. Of course, on a more serious note, the economy was also affected by geopolitical conflicts in its backyard and ongoing weakness in other Eurozone countries. However, under the surface of vacation-driven volatility, the economic success story continued as unemployment remained low, employment reached a new record high and private consumption turned out to be an important growth driver. Looking ahead, despite all public criticism, the German economy should be one of the main beneficiaries of any forthcoming QE by the ECB. Even lower interest rates should further support the housing market (the construction sector currently expects 2015 to be the best year in 15 years) and some domestic investment and further weakening of the euro is excellent news for the German export sector. Add to this extremely low energy prices, which particularly should be balm for the souls of SMEs and consumers, and it makes the ultimate stimulus package for the economy. The only downside of QE and consequently this free stimulus package is that it will probably further delay new structural reforms. But this is probably not what critics of the ECB have in mind.

Bag of mixed data

Bag of mixed data. German industrial production struggled to gain further momentum in November, dropping by 0.1% MoM, from +0.6% in October. On the year, industrial production is now down by 0.5%. The November drop was mainly driven by weaker production in the energy sector. Production in the manufacturing sector, capital goods and consumer goods continued the positive trend of the last months. At the same time, November trade data indicated that the export sector is still suffering from geopolitical tensions and Eurozone stagnation as exports dropped by 2.1% MoM, from -0.5% MoM in October. As imports increased by 1.5% MoM, the seasonally-adjusted trade balance narrowed to 17.6 bn euro, from 20.8 in October. Today’s data provides further evidence that the German economy has not yet fully recovered from the soft spell of the summer. In fact, the German economy still counts its bruises. Nevertheless, in our view, the economy should gain more momentum in the coming months, benefitting from its very special stimulus package which almost came for free. The sharp drop in energy prices and the weaker euro exchange rate are without any doubt a blessing for the economy. An economy, which actually has reached the end of a virtuous cycle and is in need of a new boost. Preferably, from structural reforms. While new structural reforms are still needed, lower energy prices and a weak euro are the well-known gift horse, which no one should look in the mouth. The drop in energy prices should particularly benefit consumers and SMEs. Contrary to big corporates, these are the economic players which simply are unable to strategically react to increased energy prices and which will now fully use the unexpected windfalls, to either invest or spend. Regarding the weaker euro, German exporters are traditionally amongst the main beneficiaries of all Eurozone countries, together with the Netherlands and Ireland. In fact, with stagnating prices at home and a weak currency, the export business should become attractive again in 2015.

Ifo signals conciliatory year-end

Conciliatory year-end. German business confidence confirmed the decent rebound of the economy in the final quarter of the year. Germany's most prominent leading indicator, the Ifo index, just increased for the second month in a row to 105.5 in December, from 104.7 in November. While the current assessment component remained unchanged, expectations increased to 101.1, from 99.7 in November. A rather disappointing year for the German economy comes to an end. The impressive growth performance of the first quarter was more than offset by a subsequent soft spell, which took longer than expected. The former growth miracle had quickly lost its glamour. With an average quarterly growth rate of 0.2% since early 2013, the German economy has morphed almost unnoticed from the Eurozone’s splendid growth engine to one-eyed in the land of the blind. In recent weeks, some of the worst concerns have subsided, though not disappeared. The Ukraine-crisis has calmed down, without being solved; the rest of the Eurozone should continue to recover, albeit at a too low pace; and the negative impact from the timing of the summer vacation has finally disappeared. Even better, lower energy prices and the weaker euro should make a decent short-term stimulus package for the German economy. As experienced in the past, the German economy is one of main beneficiaries from lower energy prices and a weaker exchange rate. Over the last twenty years, German exports to non-Eurozone countries have shown a rather unique correlation with exchange rate movements. Relatively immune against currency strengthening but strongly benefitting from currency weakening. A lucky pattern not all Eurozone countries have experienced. This positive effect should start to kick in in the coming months. Moreover, lower energy prices have already boosted every German’s disposable income by 25 euro per German. Last but not least, the fact that next year several public holidays will fall on weekends should add some 0.2%-points to GDP growth. Currently, probably the two biggest downside risks to a rosier German near-term outlook are Russia and complacency. As regards Russia, German exports to Russia have already suffered under the sanctions and the Russian slowdown, currently standing 22% below last year’s level. The current ruble crisis should now have a broader impact on German exporters as it should also affect products that did not yet fall under the sanctions. Even if Russia currently only accounts for roughly 2.5% of all German exports, direct and indirect repercussions from the current ruble crisis cannot be excluded. As regards the second risk, a recovery on the back of an external stimulus package also bears the risk of further self-complacency and a resistance to start new reforms. This year’s weakness provided further evidence that the economy is still too dependent on exports. Despite running at full employment and an almost closed output gap, private consumption has not been able to give a strong boost to the economy. Private consumption’s annual average growth rate between 2010 and 2014 almost doubled that of 2005-2009. However, at only 1% it was good but not good enough. The same holds for investment. With some slight upward momentum this year, it is still far too weak to close the gap with investment in most other developed economies, which widened between 1995 and 2009 when domestic investments grew by only 0.1% per year. There clearly is enough room for improvement. All in all, today’s Ifo reading gives a conciliatory end to an exciting but also disappointing year of the German economy. The economy once again defied premature swan songs. It’s now time to take a deep breath and enjoy Christmas, even if there is no reason for excessive backslapping.

More rebound evidence

More evidence for Germany’s rebound. October trade data just added to recent evidence that the Eurozone’s largest economy gained some momentum at the start of the fourth quarter. Exports dropped by only 0.5% MoM, from a strong +5.5% MoM in September. As imports dropped by 3.1% MoM, the seasonally-adjusted trade balance improved to 20.6 bn euro, from 18.6bn in September. The trade balance with Germany’s Eurozone peers was only slightly positive and exports to the rest of the Eurozone are only up 1.9% YoY. The fact that German exports to non-Eurozone countries are up by around 7% on the year illustrates the economy’s gradual decoupling from the rest of the Eurozone. German exporters are normally amongst the main European beneficiaries from a weaker currency. Interestingly, over the last twenty years, German exports to non-Eurozone countries have shown a rather unique correlation with exchange rate movements. Relatively immune against currency strengthening but strongly benefitting from currency weakening. A lucky pattern not all Eurozone countries have experienced. The exchange rate channel remains in our view the strongest argument for the ECB’s QE efforts. Indeed, going back to bigger macro-economic simulations indicates that ECB president Draghi was right in pointing to the negative impact on inflation from lower oil prices, rather than any positive effects for growth. As a rule of thumb, a depreciation of the (trade-weighted) euro exchange rate by only 5% could add some 0.3%-points to Eurozone GDP growth. To get the same impact from oil, prices would need to fall by at least 50%. At the current juncture, the weakening of the trade-weighted exchange rate has been less accentuated than the weakening vis-à-vis the US dollar. If it stayed at its current levels throughout 2015, the nominal effective exchange rate would only be 2.5% below its 2014 average. This seems to explain why ECB president Draghi prefers to use falling oil prices as a means to get QE, rather than hoping for the direct healing impact from oil. Looking ahead, even if it might hinder new structural reform efforts, a weaker euro is probably the best thing that could happen to both Germany and the Eurozone.

German economy makes good start into Q4

The end of the soft spell? German industrial production continued its rebound and increased by by 0.2% MoM in October, from 1.1% in September. On the year, industrial production was up by almost 1%. The increase was mainly driven by the production of intermediate and consumer goods. Moreover, production in the construction sector increased by 1.4%. Today’s data add to the encouraging data from last week when new orders increased by 2.5% MoM in October, after 1.1% in September. Even if the new order data might be slightly blurred by bulk orders, the latest positive trend from the industrial sector suggests that the initially weird sounding explanation of too many vacation at the same time during the summer was a valid reason for the economy’s weakening in the third quarter. Now that all Germans are finally back at work, the industry is rolling again. This is also confirmed by the fact the inventory build-up seems to have stopped in October. For the first time since June, inventories dropped again in November. Looking ahead, the German economy should benefit from a very special stimulus package. As experienced in the past, the German economy is one of main beneficiaries from lower energy prices and a weaker exchange rate. This positive effect should start to kick in in the coming months. Moreover, the fact that next year several public holidays will fall on weekends should add some 0.2%-points to GDP growth. Disappointing economic data since the summer months had given rise to a more general discussion about the state of the German economy. Were the numbers the start of a longer-lasting stagnation or just a soft spell? With today’s numbers the answer is clearly: a soft spell. And, even better, the soft spell should be over in the final quarter. Nevertheless, the economic rebound should not deviate from the fact that the German economy is exhausting the successful structural reforms from the past to the extremes. Even if the soft spell is over, self-complacency is definitely misplaced.