German IFO turns Iffy

Germany's widely respected IFO business climate index turned slightly lower unexpectedly in March. Rising confidence abated, business expectations took a small setback and the climate cooled.

The table chronicles a sector diffusion index treatment of the IFO survey across business sectors. The overall measure of diffusion shows a step back from February's +7.3 reading to a +6.0 reading in March. Manufacturing stepped back to +8.6 from +9.6. Wholesaling fell relatively sharply from a +6.3 to a reading of dead flat. The services sector fell from a reading of +25.1 to a reading of +23.5. Improving on the month was retailing which moved up to a flat reading from a -1.2 reading in February, and construction which moved from a +6.9 to a high reading of +7.2.

The standing for these indices in their historic queue of values is still in the mostly solid to strong range, from a high of 99.6% to a low of 72.7%, excepting the lower 57.5% standing for the manufacturing sector. The all-sector standing is in the 77th percentile of its historic queue. Excluding manufacturing the average sector standing rises to a strong 85.9%. That's fine except that manufacturing, the key sector for the German economy, is its weakest sector.

With responses arrayed slightly differently, current conditions were found to slip on the month to a diffusion reading of +8.5 from the previous month's reading of +9.1. Expectations were set back from a February reading of 5.6 to a March reading of 3.6. The expectations index standing is in its lower 70th percentile and the current conditions reading is in the upper 70th percentile both are solid readings.

In the broad scope of things, the climate, confidence, and expectations set-backs do not unseat any of their trends with this month's performance. However, business confidence had been in a relatively long slide from the middle of 2011 and has under its belt only a few months of increases which this reading now calls into question. The business climate index, similarly, has been on a long slide and has a few more months of increases under its belt, when compared to confidence. The expectations series is the one that has the strongest rebound, though a sharp gain that still is of short duration. Even with this month's setback, expectations still appear to have broken out of their downtrend. But as you can see from the graphic, all of these conclusions are tentative.

However, it's significant that we see this backtracking in the important IFO index at the same time that Markit's PMI readings are eroding for Germany as well as across the Zone and as other pressures intensify on the Zone.

All of this is happening with the Eurozone perhaps at its most significant crossroads. While the situation is Cyprus has garnered a great deal of market attention and does represent some significant risk for the euro-Zone despite Cyprus' small size, the real problem is the threat from Italy to abandon austerity. Italy, the country where the Treaty of Rome was signed, got this whole Eurozone integration started back in the 1960s and could also be the country where the progress toward more European integration comes to an end.

Italy's grass-roots opposition to more austerity has brought new political parties into power. After the last elections Italy is still unable to from a new government.

Cyprus is now the first country to reject European Community's demands as a precondition to get aid. Cyprus already has a potentially cozy relationship with Russia. That could lead it to have options beyond bankruptcy or knuckling under to the euro bureaucracy.

It doesn't end there. The Portuguese government has dismissed a no-confidence vote from the main opposition party and for now continues to say austerity is the only way ahead. Spain, after seeing its regional circumstances deteriorate, has loosened up its austerity conditions on its regions. In Germany Angela of Merkel is apoplectic.

Its relative wealth and trade account position make Italy a viable candidate to leave the Eurozone. Cyprus' small size and its connection with Russia especially the 31 billion euros deposited in its banks by Russian's give it a potential lifeline away from the clutches of the Troika. Cyprus has unexploited energy reserves that the Russian's have their eye on, and, with its Syrian port now in doubt, Russia would like a naval presence in Cyprus- a NATO country. Cyprus may have some significant bargaining chips on the table and it has two parties to play one against the other: the EU Vs. Russia.

The ECB's role in all this is pivotal as it has said that it will not support banks in its LTRO program unless the country is pursuing a course of austerity. Italy is not doing that if one of the rogue governments is seated. In the case of Cyprus, without agreeing to the EU bailout dictate its banks will not be solvent and therefore will not be candidates for further help from the ECB.

It's a difficult time for the euro-Zone's strongest economy to be showing signs of losing its momentum. But that's exactly where the euro-Zone finds itself right now as both the German economy and the future for the Zone appear to hang in the balance.