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July 23th, 2012

Despite ongoing distractions from Europe’s peripheral economies, Germany’s Ifo Business Climate Survey continues to be one of the most widely watched activity indicators in the euro area. According to the consensus derived from the latest Reuters poll of 45 forecasters, the market expects the July index to slip for a third straight month, this time to 104.7, the worst in 28 months. With the last two declines averaging 2.3 points, the market is potentially overconfident in only a modest Ifo decline in July.

Morgan Stanley Research expects the Ifo business climate index to drop by nearly two points to 103.5, after 105.3 in June. “The continuation of financial market stress and elevated uncertainty seems to be an ongoing drag for sentiment. A fall in the Ifo index would also be consistent with the decline that we saw in this month’s ‘composite’ measure of the ZEW index. However, we’ll be closely watching if a fall in the overall index will be primarily driven by the current conditions measure, as was the case in the ZEW investor expectations this past week, or whether the forward-looking business expectations will also be affected.”

HSBC Global Research counts several European activity surveys out this week as able to confirm a lackluster economic backdrop. “The German Ifo Business Climate index should ease for a fourth [sic] month in a row, the French Business confidence index should slip further from 92 to 90 and the EMU and German PMI surveys will likely confirm that the manufacturing segment remains in contraction territory.” HSBC is one point below the median estimate on France’s business confidence (91) but 0.3-point above the median on Germany’s Ifo survey.

As part of their monthly Chartbook for July released Monday, UniCredit Economics Research wrote, “The strong gap in German business sentiment indices has narrowed considerably of late. Whereas the Manufacturing PMI stabilized at an already subdued level, Ifo business expectations were down strongly for the second month in June. In our view, companies increasingly sense the pain that will come from the eurozone in the next few months. Spending cuts, tax increases and financial turmoil will keep economic activity in the EMU at a subdued level, thereby harming the export outlook for German companies. Total manufacturing orders were up 1.0% in April/May compared to 1Q12. Also, the latest export figures indicate a positive growth contribution from net exports in 2Q12. Together with broadly stable retail sales and the weather-related rebound in construction, our GDP Tracker currently indicates even some upside risks to our +0.2% qoq forecast. The weakening export outlook has reduced the willingness of firms to hire new staff. Despite more cautious investment planning by firms due to the very high economic uncertainty, domestic demand remains the major growth pillar.”

Bank of America Merrill Lynch calls for a 1.1-point drop to 104.2, as does Societe Generale Cross Asset Research. SG economists described the “three strikes” feat as signaling “a new turning point after one of the shortest uptrends in the history of the survey”; the headline index gained 3.3 points over the November 2011 to March 2012 period before stalling in April and descending a cumulative 4.5 points across May and June.

In its digest of previews for this week’s euro area releases, SG wrote, “Factors pointing to a less optimistic corporate sector are numerous: most importantly, although significant progress has been made in dealing with the euro crisis over the past month, this has gone hand in hand with yet more fiscal austerity in the periphery – and this will inevitably have weighed on growth expectations. At the same time, news about the state of the US economy has been poor over the past several months which is arguably an important factor, given that German exports to the US have grown faster in the first four months of 2012 than to any other major market. Oil prices have also rebounded over the past month, and there are widespread concerns that Germany’s shift in energy policy (no more nuclear and a big push in favor of renewable sources) will cause electricity prices to soar. And, of course, wage pressures are up significantly from past years. Lastly, the level of the Ifo index remains far too high in light of the growth rates likely in Q2/Q3. That said, the deterioration should be milder than in the preceding two months, given that growth forecasts for Germany are stable or are even being nudged higher (e.g. IMF). Furthermore, the weak euro, especially against Asian currencies, is also acting as a support.”

Despite having one of the most downbeat July Ifo forecasts in the Reuters survey, Citi Research Economics (e: 103.0) says the July headline reading is likely to stay 0.4-standard deviation above the long term average. Citi economists wrote, “While the recent depreciation of the euro probably will limit the deterioration in business expectations after two months of consecutive large falls, we expect a further reduction in business expectations from 97.3 in June to 96.5 in July (0.6 SD below average). The assessment of the current business situation, which surprisingly increased in June, is likely to fall from 113.9 in June to 110 in July (0.9 SD above average).” Relating Germany to the entire region’s performance, Citi wrote, “OECD euro area leading indicators suggest that the rate of economic activity will slow further into the third quarter. The recent deterioration in the expectations component of the Ifo survey highlights the fragility of the Q1 2012 rebound. Our model is tracking an annualized rate of -0.85% for Q2 GDP, compared to our baseline forecast of -1.5%.”

Developed Europe economists with RBS Securities forecast a decline in the Ifo headline index to 104.5 in July. They reasoned, “Our forecast includes a decline for the expectations index from 97.3 to 96.5 and a decline in the current conditions index from 113.9 to 113.0. The ZEW expectations index declined significantly last week. Furthermore, the 3-month moving average of the forward-looking Ifo export expectations index declined somewhat in June weighing negatively on our forecast.” The expectations component has a slightly higher weighting (~51.76%) than the current assessment of the business situation (~48.24%). Expectations are already at a 36-month low, while the current assessment is only at a 24-month low. Those like RBS and Morgan Stanley who believe that the ZEW leads Ifo, however, may have it backwards. While from January 2007 to June 2012 there is a convincing 92.4% correlation between the two series in the same month, there is an even higher (95.7%) correlation when Ifo leads ZEW by one month. If instead ZEW were to have a one-month lead on Ifo, the strength of the correlation over the last 5.5 years drops to 86.9%.

Problems in Europe’s periphery continue to capture media and investor attention and the Troika’s visit to Greece on Tuesday will possibly generate a series of problematic headlines. Of course, there are still the Markit® flash PMIs for Germany with which to contend before Wednesday but dealers see the fate of core Europe’s economy in the hands of the Ifo business survey, already behind in the count and seen going down swinging.


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