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Economy in Brief

IFO Registers Small Rebound on the Month
by Robert Brusca  May 23, 2022

Germany's IFO index has rebounded on the month with its climate reading rising to minus 2.8 in May from minus 5.4 in April. Current conditions improve to 26.9 in May from 21.8 in April and expectations tick slightly higher to a still negative minus 17.8 reading from minus 18 in April.

Despite the month-to-month improvements, the clear reading from the IFO is that conditions remain weak. The current index, which has the best standing of the three IFO indexes, has a standing only at its 59.9 percentile. That leaves it about 10 percentile points above its historic median that dates back to 2005. By comparison, the climate reading for all sectors is at 19.3%, weaker less than 20% of the time. The expectations index is at 6.3% and is weaker only about 6% of the time

Current conditions are thought to be cruising at a speed something slightly above normal; expectations are quite dismal. These two factors suffice to explain the complexity of conditions in Germany. Day-to-day life is at or above ‘normal’ but there is a sense of the other shoe getting ready to drop.

Inflation has risen high in the euro area, and it is now expected that there are going to be policy changes come July. This may be long overdue but better late than never. The war continues between Russia and Ukraine. While Russia is still a dominant military power, Ukraine continues to register successes on the battlefield. Still, the situation there is abysmal Ukrainian cities are being flat out leveled, decimated by ongoing Russian assaults that no longer thinly veil that they target civilians. Ukrainian people seeking to leave are put through Russian ‘filtration centers’ that try to screen out super patriots were identify any military that might be hiding among the civilian population. All-in-all the behavior of Russia in the war is eye-opening. Countries that thought they could ‘do business with Russia’ are aghast at the things that Russia is willing to do, the way it is willing to level cities and to rain terror down on civilian populations. While the West continues to pump military goods into Ukraine, that is still the extent of their help as Russia continues with its most abysmal tactics.

In this environment, it's not surprising that the German IFO shows such weakness. The climate index shows the negative headline and three sectors with negative readings with only two showing positive ratings. Those two are manufacturing and services while construction, wholesaling, and retailing log net negative readings. Despite that, all the climate readings as well as the IFO category headline make some improvement on per month.

Current conditions improved across the board in May. Retailing and services showed the largest improvements with other sectors improving for only a modest amount month-to-month.

Expectations made a bare bones improvement, rising to only -17.8 from -18 the month before. Manufacturing, construction, and retailing improved on the month. Expectations for services and wholesaling weakened.

The rankings (second from right hand column) tell the story with the current index showing few truly strong readings and for the most part readings that are moderately above their historic medians across sectors, while expectations are extremely dismal and near historic lows across all sectors. Looking at the changes in variables since the virus struck back in January 2020, current conditions show only two sectors have net improvement: they are manufacturing and wholesaling, while there is double-digit slippage in construction and retailing and substantial slippage in services. Given the weights of the sectors, the all-sector index manages to improve by 0.3 on the month.

Not surprisingly given their weak standings, there's slippage across all sectors for expectations. The headline for expectations the declines by double digits compared with January 2020 level. By sector, the weakest is construction followed by retailing followed by wholesaling. The least decline is still a 7.2 point drop in manufacturing.

The climate reading also shows deterioration compared to January 2020 it drops by 4.2 points; the drop is mitigated by increases in perceived climate in manufacturing of five points while all other sectors decline, led by a 26-point decline in construction and the 22-point decline in retailing. Clearly manufacturing carries a heavy weight.

Globally conditions continue to struggle. The U.S. economy turned in a negative growth rate for the first quarter of 2022. The Federal Reserve is raising rates and looking at a stepped-up pace of tightening to deal with the high inflation. The Bank of England is raising rates. The ECB seems ready to take some policy tightening steps in July. All these aim at reining in inflation, but of course the risk is that they rein in growth too. Typically, that's how monetary policy works. Monetary policy is unable to aim directly at inflation but must get at inflation in a roundabout way that also impacts growth.

Gee-Oh? Politics
In addition to the challenges to growth stemming from existing supply chain issues, further deterioration created by the war in Ukraine, and ramping inflation, the Russian invasion has stirred up a pot of uncertainty in Europe. Europe, long a melting pot of different economic and geopolitical interests, has seen some of these differences come to the fore as Finland and Sweden seek membership in NATO. While NATO seems welcoming, there are issues among individual NATO members, especially Italy and Turkey that have either their own agendas over NATO’s role or harbor separate bilateral issues. Nothing that is done multilaterally is done easily even where there is a clear and present danger and an obvious solution. That in and of itself is a danger.

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