Ifo Sends Warning Signal for Germany

Germany's Ifo index's expectation component dropped sharply to 6.0 in June from 8.6 in May. The index has dropped sharply over the last two months. Historically, its two-month drop is greater than this only about 17% of the time. The drop is significant but not worrisome. Moreover, the expectations reading, at 6.0, is still positive; that's good enough to indicate ongoing growth. Still, the drop in the expectations index is also enough to make us wary about the speed of growth in the coming months. Other indicators have showed some dropping off from their higher levels, such as the PMI survey. For now, the Ifo expectations component joins that wary signal.

The all-sector index continued to show an increase, but its pace fell to 11.8 in June from 13.2 in May. It stands in the 86th percentile of its historic queue. The current index, which was flat on the month, has stayed in the 84th percentile of its historic queue. However, the drop in the expectations index has left it in the 77th percentile of its historic queue, marking it as one of the weakest indicators in the table in relative terms.

The sectors check in with the highest reading for retailing which rose sharply this month to 8.1 from 4.9 in May. This diffusion standing leaves it in the 92nd percentile of its queue. The second highest queue standing is for construction, despite the fact that it has the weakest absolute diffusion reading. The third highest reading is for wholesaling, which also increased this month to 12.5 from 11.4. Its queue standing is in its 86th percentile. Manufacturing fell this month to the 15.7 from 19 in May. It has the lowest sector reading in the table standing as it does in the 75th percentile of its queue.

Remember that the queue standings place each of the indicators in its respective historic queue. Each is evaluated relative to its normal diffusion reading and its historic distribution. Although manufacturing has the lowest queue standings among sectors, it also has the highest absolute diffusion reading. Manufacturing is still growing; it is just growing relatively slowly compared what it does historically. Construction is declining, but historically its decline is so much more that this is a relatively good performance for construction.

On balance, the Ifo survey gives us reason to be wary of the future. The all-sector index steps down this month and we can see a good deal of variation among the sectors including the drop back in the all-important manufacturing sector, since Germany is so geared to exporting this is an important reading. Retailing, usually a lagging sector, is among the strongest sectors in terms of its queue standing, but that won't last if manufacturing continues to fade. The drop in expectations is clearly the most worrisome part of this report. It is something we will have to keep an eye on since we now have several different messages from Germany and the euro area warning us of the future.

In a somewhat unrelated development today, Italy's Prime Minister Matteo Renzi made an appeal for the euro area to stop its emphasis on austerity. In an earlier meeting this month, European Central Bank President, Mario Draghi had emphasized that the way forward for the European Monetary Union was to build on the progress it had made and to not engage in backsliding. Italy's pleading today (and France's ongoing under-performance) indicates the extent to which austerity continues to create substantial problems for those countries that have been locked into austerity programs for such a long time and have little to show for it. The plea from Italy is more significant since it's the third largest country of the euro area. It's not one of the smaller peripheral members.

Of course, when we hear statements of this sort from politicians, we can't be sure the extent to which it's an authentic request or demand or a tactic to try to deflect political pressures so that some kind of foreign influence can be blamed. However, it's clear that Italy is among those countries continuing to be on the cost slope of austerity curve rather than on the payoff slope of the austerity curve; that has become quite painful.

These kinds of news results are issues for all euro area members. As the euro area has discovered - if somewhat painfully - problems in one part of the euro area can become a problem for all members. This is just another reminder that confidence in Germany is having difficulty for a reason. The euro area is continuing to struggle with economic success among members uneven. Then there are geopolitical pressures as well. Perhaps the news today that Russia's President Vladimir Putin is going to ask that permission be rescinded for him to be able to dispatch troops in the Ukraine will relieve some of the pressure.

Whatever the impact of Putin's new move, it appears that we have entered a new phase in geopolitical conflict, putting Germany and the rest of Europe in the danger zone. This is being reflected in German and euro area confidence readings and could undermine actual activity.