Every morning I record a podcast in French (see here) on a specific topic. The text below is the translation of this morning podcast.
After the rebound of the ZEW index, the IFO synthetic index was up in November. Is it sufficient to sweep away all the uncertainties on the German short-term economic prospects? Certainly not
After 6 months of free fall, the two indices, ZEW and IFO, have a rebound and this one is not spectacular. For the IFO it just erases the drop seen in October. For the ZEW it has not this magnitude. Figures are still low in November
Looking at the two IFO components we see that their position in the cycle put the German economy in a deceleration zone. The current condition component is higher than its average measured on a “before the crisis” cycle (it’s easier for the comparison to take this reference) while the expectations component is lower than its pre-crisis average. This does not give the picture of a rapid improvement. Usually in the reversal of the cycle, the real change comes from expectations. At this specific moment, the future is brighter and the expectations component jumps on a higher trajectory. This is not the case in the current episode.
At a sectoral level we see that the manufacturing sector is still weak. The rebound is on a small scale. The momentum of this sector depends a lot on the world trade dynamics. This latter is not sufficient yet to be a support for acceleration in the German manufacturing sector. This was already seen in the PMI/Markit survey for November. The synthetic index was just at 50 for the manufacturing sector.
The rebound comes from the retail sector and from the wholesale sector: in other words, the internal components of the IFO are up. This is fairly good but it is not sufficient to have a business cycle reversal in Germany.
The profile of the German economic activity depends deeply on the impulse that comes from the external sector. Its contribution to GDP growth is in the long-term as strong as the contribution from the private internal demand. In other large European countries, the GDP profile reflects mainly the private internal demand profile.
If we make the hypothesis that the world trade momentum will remain reduced in the coming months then the German economic trajectory will depend only on its internal demand. According to the limited contribution to German GDP profile of this latter, we cannot expect a strong and long lasting improvement of the German economy.
This is the way the German economy will go except if the government commits to support its internal demand. It can go through consumption or through investment in infrastructure. This would be positive for the German economy but also for the European economy as it would rebalance the growth process inside the Euro Area. This would be good as it would change expectations. But this is on a longer period than the short-term analysis we had in mind.
In the coming 3 to 6 months, the economic prospects will remain gloomy in Germany as far as the world trade will not improve and without strong commitment from the government to really change the picture. For the IFO survey it would dramatically change the pattern of the expectations component on the upside.