Unstoppable optimism?

Is sky the limit? German business optimism seems to be unstoppable, paving the road for an excellent growth year 2015. Germany's most prominent leading indicator, the Ifo index, just increased for the sixth month in a row to 108.6 in April, from 107.9 in March. While the current assessment component improved to 113.9, its highest level since June last year, expectations weakened somewhat to 103.5, from 103.9 in March. The German economy is in good shape. The first months of the year point to a good, though not excellent, growth performance in the first quarter and the next quarters should not be very different. In fact, Germany remains the biggest beneficiary of the euro crisis and the ECB’s QE. Even if the weak euro has not yet entirely found its way to strong export numbers, at some point in time it should. Moreover, strong domestic demand on the back of record high employment, wage increases, low energy prices and a new appetite for consumption, driven by record low interest rates, has become an important growth driver for the German economy. Yesterday’s GfK index confirmed the picture of almost euphoric consumers. At 10.1, the index is now at its highest level since October 2001. However, before becoming too lyrical about the German economy and jumping on the bandwagon of upwardly revised growth forecasts, a brief glance at today’s expectation component and yesterday’s PMIs justifies some caution. Particularly the Greek crisis but also an unexpected longer-than-expected soft spell of the US economy and a further weakening of the Chinese economy provide reasons enough to be optimistic, but not lyrically overoptimistic. Carsten Brzeski

ECB meeting - Unexpected excitment in Frankfurt

What everyone had expected to be a rather dull press conference will go down in history as an unforgettable meeting. Not so much due to new monetary policy action or insights but due to a female protester storming on top of ECB president Draghi’s desk, spraying confetti on him and shouting about the end of “ECB dictatorship”. Luckily, no one was harmed and the woman was quickly hauled away. A stalwart Draghi continued with the press conference just a few minutes later. The rest of the press conference could hardly match the excitement of the first minutes. As expected, the ECB kept interest rates unchanged. While the ECB’s macro assessment was somewhat more positive than at the ECB’s March meeting, not a lot has changed. Draghi’s main goal today was obviously to downplay any premature tapering speculations. And, he accomplished his mission. At least for now. As regards the ECB’s macro-economic assessment, Draghi stressed the prospects for a Eurozone recovery on the back of improved domestic demand, lower oil prices, the weaker euro and also structural reforms. Draghi also pointed to still existing risks to the recovery but the most notable change in the assessment was a slight change to the risk assessment. According to the ECB, risks to the outlook are still to the downside but now “more balanced” than in March. As regards inflation, the ECB kept the same assessment as in March, which is a very gradual increase in headline inflation over the next two years. More specifically on QE, Draghi repeated that monetary policy alone could not carry the economic recovery. Governments needed to continue with structural reforms. Addressing earlier criticism, Draghi said that QE did not prevent governments from implementing reforms but was rather conducive for reforms. Asked about possible side-effects from QE, Draghi acknowledged that a protracted period of low interest rates could lead to imbalances but he did not yet see any bubbles in the Eurozone. With many government bond yields currently trading in negative territory, we indeed are curious to learn more about Draghi’s definition of bubbles. In the days leading to today’s meeting, some market participants had started to discuss the possibility of an early tapering, an end of QE earlier than the officially intended deadline of September 2016. One reason for this discussion is actually the success of QE which has pushed down the euro exchange rate. At its current level, the weak euro would mechanically add another 0.4%-points to inflation, bringing headline inflation above 2% in 2017. This could already happen at the June meeting, when the ECB will present the next staff projections. During the press conference, Draghi tried everything he could to temper the taper discussion. According to Draghi, the tapering discussion was premature. And we totally agree with him. Draghi did not get tired of repeating that the full implementation of QE was required to “provide the necessary support to the euro area recovery”. Moreover, a new sentence in the ECB’s introductory statement clearly tried to temper tapering phantasies: “When carrying out its assessment, the Governing Council will follow its monetary policy strategy and concentrate on trends in inflation, looking through unexpected outcomes in measured inflation in either direction if judged to be transient and to have no implication for the medium-term outlook for price stability” In our view, this sentence is just ECB language for saying that the ECB can do whatever it wants and use whatever indicator it wants to use to determine the end of QE. All in all, ECB president Draghi clearly tried to temper any taper discussion. Whether he will succeed, is uncertain. If the recovery really unfolds and inflation forecasts start to pick up, Draghi will not only have to temper taper speculations in the market but, even more challenging, within the ECB itself.

German economy not at full speed (yet)

Bag of mixed data. German industrial production struggled to gain further momentum in February, increasing by only 0.2% MoM. The 0.6% increase in January was revised downwards to a drop by 0.4% MoM. On the year, industrial production is down by 0.3%. The meagre increase in industrial production is mainly the result of a reversal of weather-related strong activity in the construction sector in January. The increase of activity in manufacturing (0.5% MoM) and capital goods (1.2% MoM) shows that the German industry has currently more momentum than suggested by headline numbers. At the same time, the statistical office also released latest trade data. Exports increased by 1.5% MoM in February, from a 2.1% drop in January. As imports increased by 1.8% MoM, the seasonally-adusted trade balance remained unchanged at 19.6 bn euro. Today’s trade data will do little to hush the international dispute on Germany’s high current account surplus. The country’s trade balance is moving from one record high to another. While the criticism of too few domestic investments is clearly justified, it is useful to remember that – at least in the German economy – external and internal activities have hardly ever been two sides of the same coin. It is far from uncertain that more domestic activity, be it consumption or investment, would automatically lead to a significant reduction of the trade surplus. In fact, last year’s growth performance already showed that solid domestic demand can go hand in hand with net export growth. Despite ongoing geopolitical tensions and Eurozone weakness, net exports contributed positively to German growth in three out of four quarters last year, while at the same time, private consumption grew at more than double the pace of the fifteen years before. Looking ahead, both the domestic and the external part of the German economy look set for further improvement. On the back of record high employment, low unemployment, higher wages, low interest rates and low inflation, private consumption should gain further momentum. At the same time, confidence indicators and order books send encouraging signals for growth of industrial production in the coming months, even after yesterday’s rather disappointing new orders data. Only the fact that inventories have remained unchanged in recent months provides some note of caution. The most encouraging signal, for the German industry comes from the weaker euro. Judging from earlier episodes with similar exchange rate weakness, order books are currently only moderately filled. If past performances are any guide for the future, German exporters can start rubbing their hands. Today’s data are good but not as good as buoyant confidence indicators had suggested in recent weeks. At its current level, industrial production only points to meagre growth in the first quarter. However, as there is still more good news in the pipeline, there is no need to doubt the Spring revival of the German economy (yet).

German new orders drop in February

Unexpected disappointment. German new orders dropped unexpectedly in February, indicating that the Eurozone’s largest economy is still not an isolated economic island. New orders decreased by 0.9% MoM, from an upwardly revised -2.6% in January. On the year, new orders are now down by 1.3%. It is the first time new orders dropped in two consecutive months since June 2014. Interestingly, the drop was only driven by the lack of foreign demand. New orders from Eurozone peers dropped by 2.1% MoM, from -4.9% in January, showing that the positive mood in the rest of the Eurozone has not yet led to better hard data. To some extent, disappointing German new orders data tell more about the state of the Eurozone economy than about the German economy. The German industry has left the soft spell of last summer finally behind. Despite today’s drop, order books are filled again. However, compared with the start of last year, the industry is still treading water. In fact, new orders, both domestic and foreign, are currently only back at their respective levels from early 2014. Looking ahead, confidence indicators and order books send encouraging signals for growth of industrial production in the coming months. Only the fact that inventories have remained unchanged in recent months provides some note of caution. The most encouraging signal, for the German industry comes from the weaker euro. Judging from earlier episodes with similar exchange rate weakness, order books are currently only moderately filled. If past performances are any guide for the future, German exporters can start rubbing their hands. All in all, there is no need to worry. However, today’s drop in new orders shows that after a series of almost euphoric news and indicators from Germany and Eurozone, some caution is clearly justified.

Binge shopping in Germany?

Binge shopping? German consumers have become real optimists and any worries about the current Greek crisis were clearly outweighed by low inflation and the strong labour market. German consumer confidence continued its recent upward trend. The GfK index increased to 10.0, from 9.7 last month, and is now at its highest level since October 2001. Interestingly, the willingness to buy increased to the highest level since November 2006. Over the last months, Germans have really started to spend it. Retail sales have seen an unprecedented uplift, increasing by a total of almost 6% since September last year; by far the best 4-months-performance ever. This is not a debt-driven shopping palooza but rather an indulgence-and-there-is-no-alternative consumption boom. On the back of the strong labour market, wage increases, low inflation and low interest rates, private consumption has become an important growth driver. Looking ahead, the factors behind consumption growth last year should remain intact this year. Given that Germans’ willingness to save has dropped to all-time-low, it seems that the ECB’s low interest rate has also reached German consumers. Only time can tell whether latest signs of de-saving are only a temporary phenomenon driven by low interest rates or a more structural and cultural shift. Fact is that households’ savings rate has dropped to the lowest level since 2001. All in all, even if we don’t expect excessive binge shopping, today’s consumer confidence indicator confirms our view that private consumption should be an even more important growth driver this year.

German Ifo continues upward trend in March

The gradual improvement continues. Germany's most prominent leading indicator, the Ifo index, just increased for the fifth month in a row to 107.9 in March, from 106.8 in February, indicating that the economy has gained further momentum. While the current assessment component improved to 112.0, from 111.3, expectations increased to 103.9, from 102.5 in February. Optimism has returned to the German economy. Strong growth in the fourth quarter of 2014, combined with low energy prices and the weak euro exchange rate have boosted confidence in the economy. However, before getting overly enthusiastic, one should keep in mind that hard data at the beginning of the year were less impressive than soft data. Moreover, today’s Ifo index is still only slightly above its average of the last five years. Looking ahead, the role of domestic demand as an important growth driver of the German economy should increase again this year. The strong labour market, wage increases, low inflation and de-saving on the back of record low interest rates should lead to strong consumption. In addition, exports should also pick up further as a result of the lower euro. The only unknown for stronger domestic demand is private investment. Here, favourable financing conditions have not yet led to a significant increase. The main reasons for still muted investment are probably the lack of strong incentives and continued uncertainty, the latter stemming the ongoing Greek crisis and the Russian-Ukrainian conflict. Consequently, the main risks to the positive German outlook come from the outside world. All in all, it looks as if the ECB and QE enable the German economy to extend its golden cycle without any new reforms. In fact, the economy is like a sailboat which only needs to hoist the sail and lean back to relax. Strong tailwinds could bring the strongest economic performance since 2011.

Good news show from Nikosia

As expected, the ECB today kept interest rates unchanged at its meeting in Cyprus. While Draghi was surprisingly upbeat on the economic outlook and the impact of QE, he kept a stringent stance on Greece. The ECB’s macro-economic assessment sounded as if the ECB is a bit inebriated by its own QE announcement. It was the most positive and optimistic assessment in a long while. Words like “broadening” and “strengthening” had not been used in combination with the Eurozone recovery for quite a while. In more detail, the ECB emphasized a “significant number of positive effects” from latest monetary policy decisions, as for example improved financial market conditions, financing conditions and lower borrowing costs. Moreover, the ECB stressed the fact that confidence indicators had also improved recently. Finally, lower energy prices and the weaker euro exchange rate should also contribute to the Eurozone recovery. This more positive take on the Eurozone economy was also reflected in the latest ECB staff projections which foresee GDP growth coming in at 1.5% in 2015 (from 1.0% at the December projections), 1.9% in 2016 (from 1.5) and 2.1% in 2017. It was for the first time since 2007 that the ECB projects a single year with GDP growth above 2%. With regards to inflation, ECB staff revised downwards its projections for this year due to lower actual inflation rates. More generally speaking, the ECB expects a very gradual increase of inflation over the coming years. In detail, ECB staff projections now foresee headline inflation to come in at 0% this year (from 0.7%), 1.5% in 2016 (from 1.3%) and 1.8% in 2017. To be fair, Draghi said that the ECB’s staff projections were conditional of a full implementation of all announced monetary policy measures. Don’t even dare thinking about tapering before QE has actually started. As for QE, Draghi revealed some interesting details. The ECB will start the actual government bond purchases next week Monday. Draghi repeated the January wording that the ECB will buy 60bn euro per month until the end of September 2016 and, in any case, until the ECB sees “a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2%”. The latter gives the ECB a lot discretionary power to alter the programme if need be. Draghi explicitly said that the ECB would buy government bonds with negative yields only if yield are not lower than the deposit rate. This would currently only exclude 2 year German government bonds. During the press conference, there were also several questions on Greece, QE and ELA. The bottom line of Draghi’s answers was that the ECB would only buy government bonds rated lower than investment grade if the countries are in a bailout programme and the programme is not in a review period. Moreover, the ECB could not buy more than 33% of a single issuer. For Greece, all of this means that the ECB could at the earliest start purchasing Greek bonds only in June or July, if and when Greece has reimbursed the bond expiring in June which the ECB had (partly) purchased under the old SMP programme. Finally, Draghi also said that ELA for Greek banks had been extended by 500 million euro. The ECB’s stance on Greece has definitely not softened. Overall, the ECB’s macro-economic assessment was much more upbeat than in previous months. It looks as if at least the ECB is a strong believer in the positive economic impact of its own QE programme. Admittedly, it would have been difficult for the ECB not to be positive but today’s euphoria was in our view almost a bit overdone. The warning that the more positive outlook should not lead to complacency and that now governments had to “contribute decisively” to the recovery was a standard part of the ECB’s introductory statement. However, it remains to be seen how credible this call on governments will be if at the same time the ECB will make an enormous advance payment in the form of its QE. To some extent this has some similarities with parents cleaning up their children's room and then asking them to do something as well. A strategy that might not make it into bestselling parenting guidebooks.