ZEW Index Puts a Dampener on Germany's Third Quarter Prospects

Just a week ago, the report of good increases in industrial production and new orders in July suggested a more encouraging outlook for economic activity in Germany. Today's report of the Zew index casts a dampener on this outlook. The Zew index of German institutional investors' and analysts' appraisal of the outlook over the next six months dropped sharply in September to 38.4 from 45.3 in August and the recent peak of 73.4 in December, 2003.

The index complied by the Mannheim economic institute measures the excess of respondents who are optimistic about the future over those who are pessimistic. In spite of its small sample--298 respondents in the September survey--the index often foreshadows the results of the much broader IFO survey.

According to Michael Schroeder, head of international finance at the Zew institute, "The drop reflects the fact that expectations for the global economy have cooled." leading to reduced expectations of exports. In addition, continued high unemployment suggests sluggish domestic demand.

The relationship between sentiment and actual production is far from a close one, as can be seen in the attached chart, which shows the Zew index and the industrial production index. Nevertheless, the feelings of unease concerning foreign and domestic demand, reflected in the Survey, may well have some impact on the willingness of business and consumers to increase their spending.