Friday 15 December 2017

German business confidence wobble adds to ECB rate cut expectations

German economy to slow after strongest quarter in three years in first quarter

Mario Draghi
Mario Draghi

The euro fell to a three-month low against the dollar and stocks and bonds in the region climbed on Friday, after a wobble in German business confidence added to expectations the European Central Bank will cut interest rates next month.

Asian shares had also finished the week strongly, hitting one-year highs, while benchmark US and European bond yields, which move inverse to prices, were heading for rises after a week lacking in clear direction in terms of data and sentiment.

Mario Draghi and his ECB colleagues have been sending clear signals in recent weeks that a rate cut plus a few other unconventional measures are on the cards for next month.

A weaker-than-expected reading from Germany's closely-watched Ifo business climate index as it fell to its lowest level of the year was enough to convince many ECB action was now a nailed-on certainty.

Meanwhile, the German economy is set to slow after posting its strongest quarter in three years in the first quarter.

Germany's economy grew at its fastest rate in three years in the first quarter, driven by domestic factors, while a leading indicator of sentiment signalled that expansion in Europe's largest economy is set to slow.

Strong investment and more freely-spending consumers drove the German economy to a seasonally-adjusted 0.8 percent quarterly growth rate, according to the Federal Statistics Office. That was twice the rate in the final quarter of last year and meant Germany was the growth engine of the euro zone's 9.5 trillion euro economy.

Growth was helped by milder than usual winter weather which meant the usual spring upturn was brought forward. Exports, the traditional backbone of the German economy, were a drag on growth.

"Positive impetus came exclusively from within the country in a quarter-on-quarter comparison," the Statistics Office said.

Economists and the government expect growth to slow after the strong first quarter. The government sees the German economy expanding by 1.8 percent this year, down from the year-on-year growth rate of 2.5 percent in the first quarter.

Germany's leading indicator of business morale, the Ifo index, on Friday also pointed to a reduced growth rate, falling in May to the lowest level so far this year and missing expectations.

"A lull was seen in the German economy in May," Ifo President Hans-Werner Sinn said after business sentiment dropped to 110.4 from 111.2 in April.

The drop, which Ifo economist Klaus Wohlrabe said was in part due to the impact of the Ukraine crisis, sent the euro to its lowest level in three months.


In the Ifo survey, assessments of current business and expectations of future business developments both fell.

"Today's data sent two messages: for the time being, the German economy is still playing in a league of its own, at least in the euro zone," said Carsten Brzeski of ING, adding that at the same time no economy "is invincible forever."

Ifo said expectations in the car sector had taken off, in line with news this month from the world's biggest luxury carmaker BMW AG , which said investment in new models would help it achieve record sales this year.

The firm is spending heavily in a bid to stay ahead of rivals.

In the first quarter, German plant and equipment investment grew by 3.3 percent, the strongest level in 3-1/2 years, while construction investment, up 3.6 percent, was the strongest on the quarter in three years.

Domestic demand added 1.7 percentage points to GDP in the first quarter, while foreign trade subtracted 0.9 percentage points. Private consumption added 0.4 percentage points.

But as other euro zone countries such as Spain, which had to take strong medicine to improve competitiveness, are starting to see benefits, some economists expected trade to help Germany again as well.

"We expect that exports will gain speed too. The rest of the euro zone is not doing so badly anymore," said Holger Sandte of Nordea. His bank would raise its GDP forecast for 2014 to 2.0 percent from 1.8 percent, he added.

Earlier today, the euro was down a third of 1pc on the day at $1.3621, the lowest in three months and crucially below a technical support level of $1.3636 that had held firm for almost nine months.

It's a level the single currency has flirted with three times this week but has not closed below it. This could be the first day it has done so since September last year.

"The renewed fall in the Ifo in May suggests that the German recovery may be slowing. We expect annual GDP growth of about 2pc this year and next, which will not be strong enough to drive a rapid recovery across the euro zone or to eradicate the threat of deflation," said Jennifer McKeown, senior European economist at Capital Economics.


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