German Ifo business climate index broadly consolidates March rebound in April, separate services survey recovers

In April, the headline Ifo business climate index reflecting conditions in industry, construction, and the wholesale and retail trade nudged down from 106.7 to 106.6, effectively consolidating the previous month's rebound from February's 14-month low of 105.7. The level of 106.6 compares to the most recent interim peak of 109.1 in November 2015, a cyclical high of 110.9 in February 2014, and a long-term average of 101.6. Historic extremes are a low of 83.5 in March 2009 in the wake of the Lehman collapse and an all-time peak of 114.3 in December 2010. The Ifo index's recent rebound, with expectations improving in both March and April, indicates that the momentum of German economic growth has been picking up again. The Ifo evidence is also consistent with similar improvements in the PMI and ZEW leading indicators in March/April. The Ifo institute commented on the latest data by saying that the German economy remains in a "moderate upswing".

The expectations component of the Ifo business climate survey extended its March rebound from 100.0 to 100.4. This corroborates the impression that companies have adjusted to economic problems and enhanced geopolitical instability in many emerging markets (including China). The level of 100.4 marginally exceeds the long-term average of 100.3, while falling well short, for instance, of the interim high of 104.8 seen as recently as November 2015. Interestingly, the expectations sub-index had similarly deteriorated temporarily during 2014, slipping from a 35-month high of 108.1 in January to 99.3 in October 2014 before recovering. Meanwhile, the current conditions component had a modest dampening effect, declining from 113.8 to 113.2. Nevertheless, the assessment of current activity remains quite elevated, being much closer to the 16-month high of 115.0 of August 2015 than its long-term average of 103.1. The underlying robustness of current conditions is also underlined by the fact that the most recent downward correction of some length (during April–October 2014) only extended to 108.2, never even getting close to its long-term average. Yet the all-time record of 122.2, in June 2011, is not in danger any time soon.

Adding to the generally encouraging news, today's separate Ifo survey release on the climate in the service sector – a series available since January 2005 – has recovered markedly in April, partially correcting for the significant downward correction during the first quarter of 2016. Having hit an all-time high of 34.3 in December 2015 and subsequently an 11-month low of 24.1 in March, the headline services index has now rebounded to 27.8. This recovery was supported by both expectations and current conditions. Expectations, which had reached an all-time peak of 26.9 in November 2015 before weakening to eventually 13.0 in March, have rebounded to 15.6. Current conditions increased to an even greater extent: from 35.9 (revised up from 35.6) to 40.7, which is the highest level in 2016 so far. Both components have thus widened the gap versus their long-term averages of, respectively, 11.0 and 23.3. Furthermore, in net terms, the overall service-sector index has thus only unwound the break-out to the upside of the second half of 2015 during 2016 so far. With only two exceptions during 2010–11, the April level exceeds everything observed prior to 2015 since the start of this series in 2005. During the 11 years of this service sector series, expectations have fluctuated between -25.1 (December 2008) and 26.9 (November 2015), and current conditions between -10.1 (April 2009) and 44.6 (September 2015).

Sector breakdown reveals diverging developments at the data edge

The breakdown of the main Ifo survey by sector, relating to goods production and trade, shows a split picture. The business climate in the manufacturing sector recovered for the second consecutive month and construction rebounded modestly, whereas wholesale and retail trade – driven by both expectations and current conditions – revealed deterioration. Worsening sentiment in the wholesale and retail sectors needs to be seen against the background of elevated or even – in the case of retail trade – rising levels in the preceding month.

The details show that business climate in the manufacturing sector increased from 5.4 to 6.5. This was driven exclusively by expectations, which had suffered around the turn of the year 2015/16, whereas current conditions, following two months of modest improvement, slipped marginally. Production plans were nonetheless revised upward "significantly". Meanwhile, capacity utilisation declined by 0.7 percentage points to 84.4 in the latest quarter, but this is still a full percentage point above its long-term average.

The construction sector climate rebounded from -0.5 to 0.2. Although building sector expectations unwound their March rebound, this still represented stabilisation at elevated levels following the drop from a post-unification and thus 25-year high in November 2015 during the December–February period. At the same time, the assessment of current conditions newly approached February's all-time record. A longer-term comparison underlines continuing sizeable outperformance versus the annual averages of 2011 (-6.8) and 2012 (-5.4), let alone the average of the 19-year period 1992–2010 (-29.0) that was linked to a long-lasting correction to the post-unification boom. Extremely low interest rate levels are continuing to support at present, which also explains the strong increase in building permits for housing in 2011 (21.7% y/y), 2012 (4.8%), 2013 (12.9%), 2014 (5.4%), and 2015 (8.3%). Note too that permits accelerated in late 2015, showing an average increase of 30% y/y during November–January.

Retailer climate experienced a moderate setback from 10.8 to 6.7, mainly due to the large spike for current conditions seen in March unwinding again. This volatility might be related to the early timing of Easter. The partial oil price rebound recently could also have played a role. Expectations worsened only slightly. These generally good conditions are based on persistently favourable real income developments. Indeed, apart from a brief phase in 2010/11, retailer sentiment is now at its best since the reunification euphoria of 1990/91.

Finally, the business climate in wholesale trade slipped from 13.4 to 10.6, which is still reasonably close to a 22-month high of 15.3 seen last November. The latest deterioration owed to both current conditions and expectations. Nevertheless, current conditions in wholesaling remain close to their best levels of the past three-and-a-half years, and the overall index of the sector is maintaining a sideways tendency.

Cyclical position in manufacturing sector improves on balance

The Ifo graph on the cyclical position in the manufacturing sector, which sets the diffusion indices of the current situation and expectation components against each other, signals that manufacturing activity remains in the downswing quadrant but is improving. Thus current conditions edged down from 17.0 to 16.8 while expectations, which had hit a three-year low of -8.1 only in February, increased anew from -5.7 to -3.3. The last period when manufacturing activity had been in downswing territory was between August 2011 and January 2013 (ignoring a short-lived return to boom territory during February–April 2012), which was then followed by an extensive 19-month foray into the boom quadrant. At -3.3 in April, expectations remain above the middle between their historic high of 26.8 in November 2010 and their record low of -52.4 in December 2008 after the Lehman shock. Current conditions are in even better shape, as the latest level of 16.8 remains much closer to their historic peak of 43.8 in December 2006 than to the all-time low of -52.9 in May 2009.

Historically, this indicator of the manufacturing sector's cyclical position has been switching between the boom and the downswing quadrant since May 2010, without ever entering the recession quadrant in-between. Recent developments have thus not been comparable to the recession of 2008–09, which had been so sharp because the depth of the financial market crisis had caught everybody by surprise. The Ifo graph also illustrates that cyclical developments have clearly dominated structural influences in recent years, unlike the situation between mid-2004 and September 2005, when the index remained little changed near the centre of the graph and thus showed a dominance of (restraining) structural factors. German growth has historically depended strongly on global demand, so that the magnitude and sustained nature of any recovery in this field remains important for the extent and duration of Germany's current upswing. In this cycle, however, unusually robust domestic consumer demand is providing for a degree of resilience that did not exist in the past.

Outlook and implications

Overall, the April Ifo business climate report provides further reassurance that the setback observed around the turn of the year 2015/16 was temporary. Improving consumer demand offsets persisting weak external demand linked to emerging market problems. In view of the recent oil price rebound, the recovery of manufacturing sector expectations should continue in the months ahead. The construction sector remains supported for demographic and interest rate reasons. Meanwhile, the rebound of the Ifo service-sector index in April signals that this section of the economy is also not weakening lastingly, but instead remaining at fairly elevated levels historically (given that this index hit all-time highs at end-2015). With respect to exports, it should be noted that external trade with the rest of Europe and the United States represent about three-quarters of German exports, and these regions are doing better than emerging countries at present. Finally, the near-term impact of the refugee crisis on the economy will be positive, as credit-financed government consumption is being raised currently.

The April IHS forecast for annual average GDP growth in 2016 is being kept at 1.9% (calendar-adjusted), following 1.4% in 2015. German consumer demand has been growing at about 0.5% quarter on quarter since mid-2014 and this should rather accelerate during the first half of 2016. High nominal and – given near-zero inflation – real wage growth, ongoing employment gains, and extremely low interest rates that discourage saving are all factors bolstering consumer spending.

In the medium and long term, IHS maintains – for reasons related to demographics, fiscal consolidation needs, and still outstanding structural reforms – that average annual growth will remain below 2%. We expect Germany's rate of potential GDP growth, which had temporarily improved from about 1.25% to nearly 1.75% during the past decade, will even stay below 1.50% from about 2025 onwards – although recent refugee developments suggest risks are now biased to the upside.