Euroland: Ifo Signals that We Are Heading for Better Days

• The Ifo economic expectations indicator increased sharply for the sixth month in a row. The overall Ifo index increased more modestly as it was dragged down by a small decline in the assessment of the current situation.
• A sharp increase in Ifo expectations has never failed to be accompanied by a sharp increase in German industrial production growth rates. We are confident that it will happen this time too.
• Ifo expectations indicate that the two-year government spread to the ECB refinancing rate is too high as the market has priced in rate hikes faster than the ECB is likely to deliver.
• We expect to see continued increases in Ifo, ZEW and PMI in the coming months. Our Ifo expectations model currently signals a rise to 92.2, which could easily happen next month.
• The sharp increase in Ifo expectations strengthens our case that there will be a strong rebound in Q3. We expect a couple of quarters with strong growth followed by a prolonged period of positive, but weak growth.

Details

The Ifo economic expectations indicator increased sharply for the sixth month in a row to 89.5 in June from 85.9 in April. Consensus had expected an increase to 87.0 and we expected 87.7 The overall Ifo index 'only' increased to 85.9 from 84.2 as it was dragged down by a small decline from 82.5 to 82.4 in the continued negative assessment of the current situation.

The improvement in sentiment in the manufacturing sector continues the strong trend seen in recent months. Manufacturing production plans and export expectations have increased sharply for two months now. We see this as a strong signal that the export-driven German economy is heading for better days.

Service sector expectations improved slightly while the assessment of current conditions declined by a similar amount - as a result the overall service sector business climate index was unchanged.

Assessment and expectations

A sharp increase in Ifo expectations has never failed to be accompanied by a sharp increase in German industrial production growth rates. We are confident that it will happen this time too. Ifo expectations currently signal that industrial production growth rates should increase sharply from -20.7% y/y to around -3% y/y.

The sharp increase in Ifo expectations strengthens our case that there will be a strong rebound in Q3. We expect to see a couple of quarters with strong growth followed by a prolonged period of positive, but weak growth, as declining house prices, deleveraging and the need for fiscal consolidation keeps growth down. Even with positive growth from Q3 and onwards the output gap will be substantial for years.

Ifo expectations signal that the two-year government yield spread to ECB refinancing rate is too high as the market has priced in rate hikes faster than the ECB is likely to deliver. ZEW expectations are more in line with the current level of two-year government yields. A temporary setback in government yields is a possibility - and will almost certainly happen if the ECB signals that it will keep rates at a low level for an extended period. However, the ECB is probably rather unwilling to send such signals in an outspoken way. It is more likely that the gap will be closed by the Ifo expectations index catching up with the current level of yield spread.

We expect to see continued strong increases in Ifo, ZEW and PMI in the coming months. Our Ifo expectations model signals a continued sharp increase and currently signals a rise to 92.2, which could easily happen next month. The OECD leading indicator also signals that Ifo expectations will continue to rise strongly in the coming months. The Ifo current conditions index should soon start to rise too although rising unemployment will keep it below 90 for an extended period.

Danske Bank
http://www.danskebank.com/danskeresearch

Disclaimer

This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets´ research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S, which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange. Copyright (©) Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.