Ifo business climate index encouragingly rebounds in July as wholesale sector recovers sharply

Frankfurt/Main (27.7.15) – In July, the headline Ifo business climate index reflecting conditions in industry, construction, and wholesale and retail trade rebounded from 107.5 (revised up from 107.4) to 108.0, bringing the downward correction of May/June to an early end. Current conditions contributed somewhat more to this bounce than the expectations component.

The overall index level of 108.0 compares favourably to a long-term average of 101.4 and the October 2014 low of 103.7, and it is also fairly close to its February 2014 interim high of 110.9. The May/June dip – by just -1.2 points cumulatively – and the recovery in July can be attributed to developments surrounding Greece, with the nuclear deal reached with Iran likely also boosting hopes of German exporters in July. By comparison, the downward correction of 2014 (extent: -7.3 points) had been linked to geopolitical concerns linked to Ukraine/Russia and the IS threat in Iraq and Syria as well as to emerging market problems caused by the US Fed’s shift towards less expansionary monetary policy. The historic extremes of the headline Ifo business climate index are a low of 83.5 in March 2009 in the wake of the Lehman collapse and an all-time peak of 114.4 in December 2010. The massive oil price decline and extensive weakening of the euro since mid-2014 remain important supportive factors for German companies. Ifo index developments since November 2014 continue to convey a stronger impression than the ZEW survey and the PMI data.

The Ifo survey component reflecting six-month expectations recovered modestly from 102.1 (revised up from 102.0) to 102.4, having previously weakened for three consecutive months by a cumulative -1.8 points. The level of 102.4 exceeds its long-term average of 100.2. The expectations sub-index had already deteriorated during 2014 from a 35-month high of 108.2 in January 2014 to 99.3 in October 2014, before rebounding in part to 103.9 in March. For comparison, the Lehman related all-time low had been massively lower at 78.6 in December 2008. Meanwhile, the current conditions component rebounded more strongly from 113.1 to 113.9, almost returning to May’s 11-month high of 114.4 and close to the March 2014 two-year high of 115.3. The underlying robustness of current conditions is also underlined by the fact that the interim April-October 2014 downward correction to eventually 108.2 never undercut the interim trough of 106.6 in December 2012, not to speak of the long-term average of currently 102.8. That being said, the all-time high of 122.0 (June 2011) remains out of reach for now given the ongoing restraining influence exerted by persisting uncertainty about a potential future Greek exit from the Eurozone.

In contrast to respective developments in June, today’s separate Ifo survey release about the climate in the service sector – a series available since January 2005 – portrayed a more negative picture than the main Ifo business climate data. Although its most recent upward tendency since December 2014 remains intact, the headline services index corrected from a four-and-a-half-year high of 27.4 to 25.9. This dip at the data edge was exclusively driven by the expectations component, which broadly unwound June’s increase and fell from 18.3 to 14.9 (long-term average is 10.3). By contrast, current conditions rebounded from 36.8 to 37.6, close to May’s all-time high of 38.1 and well above their long-term average of 22.0. Overall service-sector confidence had followed a sideways tendency between mid-2012 and November 2013 before breaking out to the upside around the turn of the year 2013/14 and then establishing another sideways trend at a new elevated level for a year. During more than ten years of history of this service sector series, expectations have fluctuated between -25.0 (December 2008) and 26.0 (November 2010), and current conditions between -12.9 (May 2009) and 38.1 (May 2015).

Meanwhile, the breakdown of the main Ifo survey by sector, relating to goods production and trade, reveals that the chief factor responsible for July’s rebound was the wholesale trade sector, with manufacturing aiding slightly as well. The wholesale trade index rose to its highest level since February 2012, a massive improvement of current conditions being accompanied by a moderate rise in expectations. By contrast, only expectations improved in the manufacturing sector, whereas current conditions worsened slightly as capacity utilization has slipped by 0.1 percentage point to 84.2%. The July Ifo report again made no mention of export prospects. Meanwhile, the construction and retail sector both showed moderate declines. The difference is that in construction current conditions were to blame for this while expectations improved again, whereas deteriorating expectations were behind the slippage in the retail sector, with current conditions providing a partial offset. In a long-term perspective, current construction sector conditions are still at historically elevated levels clearly exceeding those seen during a near-20-year period between 1992 and 2010. Similarly, the overall retail sector index remains broadly in line with extremely favourable conditions for consumers.

Overall, the July Ifo business climate report reflects a relief reaction to Greece not having exited the Eurozone (for now), with the deal with Iran probably also having supported. The burdening factors weighing on business confidence for most of 2014 – notably the uncertainty created by ongoing geopolitical tensions in the Ukraine and the Middle East and the inability of the Eurozone as a whole to embark on a meaningful economic recovery path – have receded in importance and partly been reversed, whereas the supportive influence from major oil price and euro declines and extremely low interest rates are coming more to the fore now. In any case, the Greek situation should be considered a restraint on achievable German growth momentum, but not as a factor able to derail Germany’s upswing as such. German GDP growth is expected to fluctuate around the 2% mark in annualized terms during the coming quarters.

The latest IHS forecast for annual average GDP growth in 2015 is 1.7%, up from 1.6% in 2014. This refers to calendar-adjusted data – the 2015 forecast in non-adjusted terms is in fact even 1.9%. German consumer demand has been growing at a pace of around 0.7% q/q since mid-2014 and should broadly maintain this momentum during the remainder of 2015. This is being fuelled by high nominal and – given near-zero inflation – real wage growth, ongoing employment gains, and extremely low interest rates that discourage saving. Our current GDP growth forecast for 2016 is 2.1%, which translates to 2.2% in non-adjusted terms.

Timo Klein Dipl. Volkswirt / Senior Economist