Carsten Brzeski’s blog

German Ifo sends wake-up call in January

Flabbergasted? It looks as global events have finally reached German companies’ boardrooms. At least this is one conclusion of today’s Ifo reading. Germany’s most prominent leading indicator, the just released Ifo index, dropped to 107.3 in January, from 108.6 in December; the lowest reading since February 2015. Particularly expectations have taken a hit from recent market turmoil and probably renewed concerns about a slowing of the Chinese economy, dropping to 102.4 in January, from 104.6 in December. The only marginal drop of the current assessment component (to 112.5, from 112.8), however, indicates that the positive growth momentum is currently still there. Even if the Ifo index recently has lost some of its predictive power for GDP growth, the current assessment component has still the best track record in nowcasting real economic activity. Therefore, there is no need to get overly concerned about German growth, yet.

Nevertheless, over the last months, strong confidence indicators and rather sluggish hard data posed a bit of a new conundrum in the German economy. Now it seems as if the soft data is converging with the hard data, rather than the other way around. The Ifo index, however, masks a more detailed look at what is currently happeining in the German economy. In fact, it is mainly the manufacturing sector, which is struggling to gain momentum. While the manufacturing sector has been treading water throughout the year and weakened in recent months, the construction, retail and wholesale sectors have been driving the strong Ifo index performance in recent months. Another piece of evidence that the German economy is currently mainly driven by domestic factors. Moreover, the fact that the Ifo index for the service sector has recently climbed to its highest level since early 2005, provides further evidence for the decoupling of manufacturing and services. A trend not only observed in Germany.

While at least at first glance the economy is cruising along smoothly on the back of strong domestic demand, the inflow of refugees remains the number one topic in German politics, media and society. Over the weekend, this discussion and the stance of Chancellor Merkel could have taken another interesting twist. As so often in the past, it was not Merkel who came up with a new plan but one of her party allies, Julia Kloeckner. Kloeckner is the leader of Merkel’s CDU in the state of Rhineland-Palatinate and running for the office of minster-president in the regional elections in early March. According to this plan, Germany would set up “border centers” at the frontier with Austria and also includes daily contingents of refugees accepted into Germany. Ironically, this plan is called A2, not plan B. Up to now, Merkel had refused to discuss a plan B. In our view, the proposal is a strong attempt to find a face-saving compromise for Angela Merkel to get out of an increasingly difficult and complex situation. In fact, the name “A2” says it all. The pressure from her own party, the Bavarian sister party and high reluctance from European partners to cooperate has put her own interpretation of “yes, we can” on a very fragile footing. Currently, the price for such a manouvre could be new tensions with the social-democratic coalition partner (SPD), who up to now have been supporters of Merkel’s plan A.

All in all, today’s Ifo index is clearly not bad enough to kick-start a new economic debate. The refugees and the political reactions will remain topic number one in the coming weeks. However, today’s Ifo index also shows that a scenario which dominated financial markets over the last weeks has finally entered German companies’ boardrooms: it’s the scenario in which extremely low oil prices could do more harm than good (at least to the German economy).