Chart of the Week : Tough week for the German economy
Head of Macroeconomic Research
Summary: In today’s ‘Macro Chartmania’, we focus on the German economy which accounts roughly for 1/3 of the eurozone economy. Headwinds are increasing at a fast pace. Yesterday, the IFO business survey for this month fell sharply to 88.6 after a strong start of the year. Last week, the flash composite PMI for July dropped under the threshold of 50 for the first time since last December (indicating business activity is in contraction). Expect Q2 German GDP to contract (the first estimate is released on Friday this week). If business activity remains gloomy for the rest of the summer, the German economy is likely doomed for a technical recession this year.
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Sentiment in the German economy has dropped in July : At the start of the year, the German economic outlook was rather positive (the IFO business climate index was at 98.8 in February, just before the start of the Ukraine war). Household balance was strong and companies were satisfied both with the current assessment and the expectations. This is not the case anymore. The macroeconomic outlook has radically changed in the space of a few months. Companies are now betting on a long economic and energy crisis. The drop in the business climate continues this month, with an index out at 88.6 from 92.2 in June. The downturn in the business climate is driven by expectations for the next six months – which decreased to 80.2 in July from 85.4 in June. This is the sharpest drop since March and the third largest drop since the pandemic started. Recent surveys have confirmed risks to growth are tilted to the upside – think the flash German PMI estimate for July which was out in contraction territory last week, for instance. The stage is set for a gloomy summer season and, perhaps, an even worse winter season if the energy crisis becomes more acute.
We have plotted the expectations component and the current assessment together -see below chart. This usually gives us a signal on the future trend of the IFO business survey. We can take it as a leading indicator of the leading indicator. The current signal is quite ugly. It now stands at minus 17.4 – the lowest level on record. The previous lowest points were at minus 7.2 (Global Financial Crisis), minus 4.9 (Eurozone sovereign debt crisis) and minus 11.7 (Covid outbreak). This will translate into lower investments and hirings in the months ahead.
Downturn across key sectors : The business climate in manufacturing dropped to 90.2 in July from 93.5 in June. In this sector both the current assessment as well as the expectations component are in a free fall. The manufacturing is still exposed to supply shortages and dislocations in international shipping (there is little improvement, actually). Adding to that inflation across the board which is seriously harming margins. The business climate for the services fell sharply to 1.4 in July from 12.8 in June while expectations reached their lowest post-Covid level at minus 24.1. We could assume the travel industry is in a better shape (after two summers in a row of restrictions, Germans want to travel). This is not the case. The business climate has started to slowly get down. The index was out at 23.3 in June versus a post-Covid peak at 24.5 in May (there is no data for July yet). Expectations are worrying too (32.7 in June versus 50.6 in May).
Germany is on the brink of a technical recession : The June IFO survey adds to previous recessionary signals. Germany is facing a perfect storm (supply chain disruptions, inflation across the board which is denting consumption, energy crisis, lower global demand etc.). Next Friday, the first estimate for 2Q GDP growth will be released. Expect a contraction. If business activity remains subdued over the summer and energy crisis issues increase, the German economy will likely face a technical recession this year. The energy crisis is a much bigger issue than inflation for Germany, in our view. Last week’s reopening of the NordStream1 pipeline has helped to fill up the country’s gas reserves. They are now at 66%. But they are unlikely to reach the minimum threshold of 90% before the winter period. German politicians are trying to revert unwise energy policy decisions (such as the closure of nuclear power plants). But it will take time before it has a positive impact on the energy supply. We increasingly fear that the German government will need to resort to the rationing of electricity this winter. This will push industrial production in a free fall. No need to say that recession would follow up soon after.
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