IHS: German manufacturing sector drives Ifo business climate
index to highest level in post-unification era in May
Frankfurt/Main (23.5.17) – In May, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade posted its seventh increase during the last nine months, increasing from 113.0 (revised up from 112.9) to a post-unification and thus post-1990 high of 114.6. This is therefore even higher than during the heyday of the post-Lehman recovery of 2010-11 when GDP growth temporarily reached 4%. Germany’s business climate is now well above the interim high seen just before the UK referendum on Brexit last June (108.9), not to speak of its long-term average of 102.0. For comparison, historic extremes are a low of 83.5 in March 2009 in the wake of the Lehman collapse and an all-time high now in May 2017. The Ifo recovery broadly matches the improving manufacturing PMI index since the autumn months of 2016. The Ifo institute comment on the latest data by saying that “the mood among German business was euphoric in May”.
The expectations component overcame April’s slight correction and improved from 105.2 to 106.5. This is the highest level since February 2014 and well above its long-term average of 100.5. Current conditions increased by an even larger margin from 121.4 (revised up from 121.1) to a new all-time peak of 123.2. The previous record had been set in mid-2011 at 122.3 in the context of the post-Lehman recovery. Note that the last time that the current conditions index has been below the present long-term average of 103.7 was seven years ago, and the last downward correction of some length (April-October 2014) troughed at 108.3. It appears that the high degree of international political uncertainty during the past year, which in part remains ongoing with respect for instance to US developments, no longer weighs down on German business optimism. The encouraging outcome of the French presidential elections (from a business perspective) has most likely helped in recent weeks.
Note that the release of the separate Ifo survey about the climate in the service sector – a series available since January 2005 – will now always be a day after the release about conditions in industry, construction, and wholesale and retail trade described above. In April, the services survey (released on 25 April) had revealed a fifth consecutive decline following an all-time high of 35.8 in November 2016, slipping from 26.5 in March to 25.5. This therefore contrasts with the improving picture in industry, construction, and wholesale and retail trade. Expectations slipped only slightly from 10.6 to 10.0 this time, however, which is a little below its long-term average of 11.6. Expectations had reached an interim peak of 24.4 in October 2016 and an all-time high of 26.2 in November 2015. Current conditions were unable to hold onto or even extend their near-4-point March rebound, declining from 43.7 to 42.0. Nevertheless, compared to expectations, current conditions remain closer to their all-time high of 47.9 of November 2016 and well above their long-term average of 24.7. The development of the last two years reveals that the overall service-sector index initially unwound the break-out to the upside observed in the second half of 2015 during Q1 2016, then rebounded anew to a record level in November 2016, but has since encountered a fresh setback. During the twelve years of history of this service sector series, expectations have fluctuated between -25.6 (December 2008) and 26.2 (November 2015), and current conditions between -10.4 (April 2009) and 47.9 (November 2016).
Meanwhile, the breakdown of the main Ifo survey by sector, relating to goods production and trade, reveals improvements in all sectors but retail. Business sentiment in manufacturing has been showing a fresh upswing since February and is now at a near-six-year high. Expectations and current conditions both boosted the manufacturing sub-index markedly in May, and the Ifo institute has highlighted that investment goods producers in particular became more optimistic as order books fill and plans abound to raise production levels. Construction sentiment was driven by yet another major improvement in current conditions to a fresh post-1991 high, whereas expectations were broadly steady but at historically fairly elevated levels. The overall index in the building sector almost matched its December 2016 (post-unification) all-time high in May. The Ifo institute add that building sector activity has picked up markedly. Business climate in the wholesale sector improved only modestly, as a rebound in expectations was partially offset by a downward correction in current conditions from April’s all-time high (since 1991). Finally, retail sector sentiment, which had been the driving upward forced in April, gave up some of those gains in May, affecting both current conditions and expectations.
Overall, May’s Ifo business climate report was better than expected and fully confirms that growth momentum in the German economy is picking up at present. It corroborates a similar message to that conveyed by rising German manufacturing PMI data since last September. Manufacturing sector exports are apparently benefiting from brighter global demand prospects and the weaker euro, and construction, which continues to be structurally supported by factors such as demographics and persistently low interest rates, is really taking off now. Notwithstanding May’s correction, the retailer climate is recovering as consumers have digested the shock of the spike in inflation during December-February. It will have to be seen whether the climate in the services sector also finally rebounds in May (release 24 May) after the recent slippage, which would corroborate this view.
The May IHS Markit forecast for (calendar-adjusted) GDP growth in 2017 has been raised from 1.9% to 2.0% and that for 2018 from 1.8% to 2.0. Underlying growth momentum is now around 0.6% q/q, although it should be kept in mind that a recoil effect affecting construction output after the mild winter is likely to dampen second-quarter growth to 0.5%. The recent election of Emmanuel Macron to the French presidency is encouraging the general European growth picture, and this is only partially offset by potentially disruptive developments linked to the Brexit negotiations and possible policy decisions towards more protectionism by the Trump administration in the US. Timo Klein
Robust German headline GDP growth in Q1 even understates underlying momentum given unexpectedly large fall in stocks
Component data now released for the first quarter of 2017 confirms – as already shown by flash data released by the Federal Statistics Office (FSO) on 12 May – that German real GDP increased 0.6% quarter-on-quarter (q/q). This represents continuous acceleration given a low-point of 0.2% q/q in Q3 2016 and growth of 0.4% q/q in Q4. The growth pace in early 2017 thus exceeds the 0.4% average observed during 2013-2016. Furthermore, the first-quarter expenditure breakdown reveals a positive surprise because headline data was actually restrained by a sharp swing of stocks – following a boosting impact of 0.4 percentage points to quarterly GDP growth in Q4, inventories have now cut 0.4 percentage points in Q1. This means that final domestic demand, i.e. net of inventories, accelerated from 0.2% to 0.6% q/q. This is the fastest pace since early 2016 and exceeds the 0.4% average growth of final domestic demand during 2013-16. Elsewhere, the data broadly conforms to expectations that have been based on the FSO indications in their press release of 12 May. Export growth outpaced import growth, so that net exports switched from being a burden on overall GDP growth in Q4 (by 0.2 percentage points) to giving a boost to the tune of 0.4 percentage points. In other words, German GDP growth in Q1 would have posted 1.0% q/q and thus 4% annualized if inventories had not restrained matters. All domestic demand components contributed positively to first-quarter growth, led by investment in construction and then investment in equipment. Even private and public consumption growth strengthened compared to the pace in the fourth quarter, however.
The year-on-year growth rate of overall GDP unadjusted for calendar factors has jumped from 1.3% to 2.9% y/y, almost returning to the five-year high of 3.2% seen during the second quarter of 2016. Both of these peaks owed to the quarter boasting three additional working days compared to the year-ago quarter, whereas the data in Q3 and Q4 2016 was restrained by modestly negative calendar effects. By contrast, the seasonally and calendar-adjusted series has been almost steady for the last two years, showing either 1.7% or 1.8% y/y in all quarters since Q2 2015 except for Q4 2015 (then 1.3% y/y). As already revealed on 12 May, revisions to data history only affected the two latter quarters of 2016, and they were very small and in opposite directions. The data prior to 2016 as the previous year has been left untouched anyway, as is the normal procedure for the May release. Taking into account the negative swing of inventories in the first quarter, underlying annualized GDP growth momentum in the German economy has accelerated to more than 2% in recent months.
Looking at developments of the individual components in Q1 in more detail, the breakdown reveals the following about GDP growth contributions: Net exports added 0.4 percentage points to quarterly GDP growth, having subtracted 0.4 and 0.2 points in Q3 and Q4 of 2016, respectively. Domestic demand net of inventories added 0.6 points, thus rebounding from only 0.2% in the previous quarter (and also 0.2% on average during the three latter quarters of 2016). The stock of inventories declined markedly in early 2017, which on its own hurt quarterly GDP growth by 0.4 percentage points. This contrasts with the boosts of a similar magnitude in the two preceding quarters, which had surprised to some extent in view of the additional factors fanning geopolitical uncertainty in that period (UK decision for Brexit in late June and the election of Donald Trump to the US presidency in November). It appears that European concerns about populists potentially dictating the political agenda in key Eurozone countries after elections was more relevant for firms’ hesitancy to build up stocks. As many of those fears have dissipated with the election of Emmanuel Macron to the French presidency, confidence and thus stocks are expected to bounce back in the current quarter. Among the components of final domestic demand, fixed investment contributed 0.3 percentage points to quarterly GDP growth, private consumption 0.2 points and public consumption 0.1 point. Within fixed investment, construction investment led the way with 0.2 points (helped by another very mild winter), while investment in equipment contributed 0.1 point. “Other investment” (intellectual property, livestock, agricultural crop) also contributed positively, but only to the tune of 0.03 points.
Private consumption growth at 0.3% q/q has strengthened modestly versus the previous quarter’s pace of 0.2%. This remains weaker than the 0.5% average seen between mid-2014 and mid-2016, as the marked upturn in inflation between less than 0.5% in mid-2016 and around 2% in recent months has made itself felt. Nevertheless, the domestic environment for consumer spending remains very favourable, given healthy labour market and wage developments and an ongoing extremely soft monetary policy by the ECB that keeps interest rates near record lows and thus renders saving unattractive.
Government consumption accelerated from 0.3% (revised down from 0.8% originally) to 0.4% q/q. This is only about half the average pace seen since mid-2014 but compares favourably with a quarterly average of 0.3% q/q during 2010-14. The more rapid pace of government consumption growth between mid-2014 and mid-2016 was linked to an ongoing loosening tendency of German fiscal policy (more spending on infrastructure and slightly reduced income taxation), which is in part due to the need to care for a large number of migrants/refugees. Furthermore, tax revenues continue to surprise to the upside, driven by growing employment and fairly healthy wage increases. This has already enabled budget surpluses of 0.3%, 0.7%, and 0.8% of GDP in 2014, 2015, and 2016 respectively. These are post-unification/post-1991 highs if one disregards a one-off surplus of 0.9% in 2000 that had benefited from the special factor of a sale of UMTS frequency licenses for mobile phone networks. The fact that these surpluses have been possible despite the additional fiscal spending on migrants confirms that Germany remains in the favourable position of being able to provide fiscal stimuli without seriously risking renewed slippage into deficit in the foreseeable future.
Fixed investment increased 1.7% q/q in Q1, following only 0.4% in Q4 and even declines in the two preceding quarters. The strong performance in early 2017 was mostly driven by construction investment, which accelerated from 0.8% to 2.3% q/q as a mild winter provided additional impetus. Investment in equipment also improved markedly from -0.1% to 1.2% q/q, however, which is roughly the average growth pace observed between Q2 of 2015 and Q1 of 2016. During the three subsequent quarters, high levels of global uncertainty (Middle East unrest and associated terrorism, politically destabilizing impact of refugee crisis, Brexit fears, uncertain economic consequences of the Trump presidency) had dampened the incentive to make long-term commitments based on expectations about future demand. This reticence appears to have been overcome in recent months now. Note that “other investment” as the third element of fixed investment increased 0.8% q/q in Q1. Recent leading indicator evidence regarding the building sector, most notably the construction sub-index of the Ifo business climate survey now available until May, points towards further strengthening of construction sector activity in the quarters ahead. Finally, note that gross overall investment, i.e. including also inventories, dropped sharply from 2.5% q/q in Q4 to -0.5% q/q in Q1. This is misleading as it only reflects the large negative swing of inventories which is most likely to reverse in the second quarter in view of the favourable overall economic background at present.
The positive contribution to GDP growth of 0.4% from external demand owed to exports of goods and services (1.3% q/q, following 1.7% in Q4) growing considerably faster than its import counterpart (0.4% q/q, following 2.5% in Q4). The ongoing rise in trade volumes generally underpins the impression of accelerating global demand that appears to be shaking off the restraining effects from various political crises. Note that German imports will rarely lag exports in any dramatic way due to the purchases of intermediate goods required for exports of finished goods. Looking back at the period since mid-2014, exports and imports have been growing at a solid average pace of 1.0% and 1.1% q/q, respectively. Note that the export orders component of Germany’s PMI survey, which had temporarily weakened from a 22-month high of 53.5 in December 2015 to 50.2 in March 2016, initially recovered to the region of 55.0 in late 2016 and has now even reached a seven-year high of 60.2 in May. Exports should thus continue to do well during the remainder of 2017 and likely beyond, preventing net exports from becoming a burden on GDP growth despite the import pull exerted by strengthening domestic demand.
The latest indications gleaned from key leading indicators are very encouraging. Thus purchasing manager (PMI) data and the Ifo business climate survey have improved to multi-year highs in May, the latter even reaching a new all-time high in post-unification times (since 1991). The main factors underpinning the optimistic outlook are the ongoing support to consumer purchasing power provided by healthy employment and wage growth and the expansionary course of both monetary policy by the ECB and fiscal policy from the government (expenditures on refugees and infrastructure are rising, financed by the existing budget surplus). Furthermore, residential construction enjoys an ongoing upward trend due to extremely favorable financing conditions and a lot of structural demand, not least also due to the large number of immigrants that require housing. Finally, growth forces in Europe at large have been picking up in recent months, which is helping exports. Risks remain with respect to any unexpected developments of Brexit negotiations or major protectionist steps in the US, but Germany’s domestic economy has developed a large degree of intrinsic resilience in recent years that should cushion any damaging external influences.
Overall, IHS Markit has projected in its May forecast round that calendar adjusted year-average German GDP growth, following 1.5% in 2015 and 1.8% in 2016, will accelerate to 2.0% in both 2017 and 2018. Unadjusted for calendar factors (as used for official government forecasts), growth will slip marginally from 1.9% in 2016 to 1.8% in 2017, as calendar factors swing from a positive effect of 0.1% in 2016 to a negative one of -0.2% in 2017. This needs to be taken into account, however, so that the underlying pace of economic growth can safely be said to have at least reached if not exceeded 2% now. Notwithstanding the anticipated recoil effect for construction in Q2, quarterly growth should fluctuate around 0.6% q/q during the remainder of 2017.
Timo Klein