Commerzbank:
This week, German sentiment indicators have given the thumbs down.
In contrast with autumn 2014, there are now good reasons for expecting weaker growth: Tailwinds from the 2014 euro depreciation are fading, and the difficulties faced by China and other emerging markets are taking their toll. The same is also true of other euro zone countries, which means that rosy forecasts, including those of the ECB, are set to be revised downward.
There is a growing chance that the ECB will do more at its March meeting than simply lowering its deposit rate. Downturn in German sentiment, … In February, the two most important sentiment indicators for the German economy – the PMI for manufacturing and the Ifo business climate – sent a forceful signal by declining significantly.
For both indices the moving averages are also in decline, which in the past has proved a highly reliable herald of economic downturns (see chart 1).1 The criteria used by the Ifo Institute itself, such as the three-month rule or the Ifo business cycle traffic light, confirm what is indicated by the moving averages.2 … and for a good reason Admittedly, there are sometimes false alarms from the sentiment indicators. In 2014, for example, they dipped sharply but the economy did not in fact slow down much.
This time round, though, the German economic environment has turned far less favourable, as apparent from our Early Bird indicator, which comprises monetary policy, the global economy and forex market developments, all of which are key influences on the German economy. This indicator started to point upwards again as of early 2014, heralding a brighter economic environment, but has been retreating since last spring (see chart 2).
There are two main reasons for it doing so: • Stronger euro: The economy received a good boost last year from the euro’s temporary weakness. The real external value of a notional D-mark in spring 2015 was down over 8% on the same period a year earlier (see chart 3), which meant that at times the impetus from the forex market was on a scale last seen at the turn of the millennium.
The moving averages have been selected such that there is less than 10% probability of a wrong signal. See ‘Leading indicators: how they can help investors now’, Week in Focus, 20 February 2009. 2 The Ifo Institute itself talks of an upper (a lower) turning point of its indicator if it has fallen or risen for three consecutive months. The Ifo economic signalling system is based on an econometric model which derives from the change in the business climate index the probability of a downturn or an upturn. This system was already pointing downwards in January.
Week in Focus Since then, however, the euro has made strong gains, especially against emerging market currencies, so that in February the external value is likely to end up almost 2% higher than a year ago. In other words, support from the forex market is clearly receding. • Weaker global economy: The global economy has obviously lost momentum, and the global manufacturing PMI is now only just above the 50 mark, which serves as the demarcation line between contraction and expansion (see chart 4).
One prime reason here is the problems besetting China and other emerging markets, which are suffering now from the after-effects of a long period of cheap money. And this situation is unlikely to change much in the near future. In China, the process of correction in the oversized construction industry and overly high corporate debt has not even begun.3 As a result, demand for German products from emerging markets can be expected to increase even more slowly in the foreseeable future than it already has been doing. Germany is representative of the euro zone What does all this mean for the euro zone?
The no more than moderate pace of growth seen recently in Germany may have different causes from elsewhere in the region; it is more likely to stem from the fact the economy was already at a high level of capacity utilisation, whereas in other euro zone countries such as France and Italy, the reform backlog and the real-estate and private-sector debt overhangs are the main causes. However, the most recent fall in leading indicators is due to similar reasons both in Germany and elsewhere in the euro zone. Since the turn of 2014/15, the somewhat stronger growth seen in most euro zone countries can be attributed to the weaker euro.
This prop has now been removed. What is more, these countries are also feeling the pinch of slower growth in demand from the emerging markets – even if their manufacturers are less involved in this area than their German competitors. So it is hardly surprising that the leading indicators are also pointing downwards for other euro zone countries. Both the manufacturing and services PMIs for the euro zone excluding Germany have fallen in the past two months (see chart 5, p.4). In other words, the signs here also point to slower growth rather than an improvement, even if they are not yet as clear as for Germany.
Downward revisions on the cards, … Under these circumstances, even our 2016 growth forecasts for Germany and the euro zone of 1.3%, which are already well below consensus, may be subject to downside risks. For the economy to achieve our forecast, after all, it would have to expand by a decent 0.3% per quarter, as in the second half of last year. Most economists are in fact assuming qoq growth rates of ½% if their 2016 annual consensus forecasts for Germany of 1.8%, and for the euro zone of 1.6%, are to materialise. So in the months ahead many economists will no doubt be forced to revise their growth forecasts, lowering them quite substantially in some cases.
