The Abruptness of Germany's Slowdown

August 26, 2008

Some members that participate in the European Monetary Union have economies in worse shape than Germany, important countries like Italy, Spain and France.  Because Germany has the region’s largest economy and in light of the abruptness of its turn for the worse, the slowdown in Germany has hurt confidence in the euro the most.  Germany reported a trio of poor indicators today.

  1. Real GDP had expanded 2.9% per annum in the three years between 1Q05 and 1Q08 but fell 2% at a seasonally adjusted annual rate in the second quarter.  Personal consumption recorded a third consecutive quarterly drop, declining over 1.5% saar during that stretch.  A big drop in construction of 3.5% annualized was to be expected after a 5.7% jump in 1Q related to a mild winter, and this doesn’t worry me.  My concern is that other investment in machinery and equipment slid 0.5% not annualized, extending an adverse progression from increases of 1.6% in 1Q08 and 3.8% in 4Q07.  Business spending has been a mainstay of German growth in recent years and still posted a rise of 10.1% from 2Q07.  The drag of private domestic demand last quarter was mitigated by a positive 0.4 percentage point growth contribution from net foreign demand, but that boost occurred because of very weak imports (down 1.3%), not strength in exports, which actually edged 0.2% lower.  It took a long time for the German economy to reap the benefits from public- and private-sector restructuring.  As recently as 2004 and 2005, real GDP had risen only 1.2% and 0.8%.  A new period of growth well below trend seems to be now under way.
  2. National income accounts are backward-looking.  The IFO index of business sentiment in trade and industry captures the present situation and expectations of business for the coming six months.  Between end-2007 and May of this year, the IFO index had risen 0.4 points on balance, as a 1.9 point rise in present conditions slightly outweighed a 1.1-point drop in expectations.  However, in the ensuing three months, the IFO index slumped 8.6 point to 94.8, lowest since June 2005.  Current conditions fell 6.2 points, and expectations — a bellwether of how the overall index is likely to move in coming months — dropped 10.1 points.  Never before has the expectations component declined so sharply over a three-month interval.  Between readings in May and August, all key sectors deteriorated, led by retailing (down by16.8 points to -21.4) and including drops of 9.3 points in wholesale activity, 8.0 points in manufacturing, and 6.6 points in construction.  In conjunction with a composite PMI score reported for August last Thursday of 50.3, down from 52.1 in July and constituting a 61-month low, the IFO figures strongly suggest negative growth again in 3Q08 and continuing weak, and possibly negative, growth in 4Q.
  3. Today’s German consumer confidence report for September deepens the pessimism.  Such was a half-point weaker than anticipated at 1.5 after a downwardly revised 1.9 score in August, 5.6 in May, and 7.3 a year ago.  Like the composite PMI, consumer sentiment hasn’t been this weak since the middle of 2003.

The surprising and discouraging thing about all these poor indications is the lack of any positive reaction to a retreat in the Euro and oil prices or to the resultant fading of expectations that ECB officials might raise interest rates further.  For the month of May, EUR/USD averaged $1.5571, and oil futures posted a mean value of $134.08.  Compared to those levels, the euro and oil are presently weaker by 5.8% and 12.8%, and the ten-year bund yield is now 18 basis points lower than three months ago on May 26th.



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