GERMAN IFO DISAPPOINTS, AT FIRST GLANCE
One of Germany’s most reliable gauges for economic activity failed to turn up in January, thereby disappointing expectations of a small uptick. After gains in three of the previous four months, the Ifo business climate index fell from 96.3 in December to 95.9 in January (see Chart 1). The decline was led by a drop in expectations among service providers which had surged in December (see Chart 2). However, the further rebound in business expectations in the highly cyclical manufacturing sector still supports the call that the German – and Eurozone – economy will regain some momentum over the course of this year.
First the bad news: After the slight miss by Eurozone PMIs – not the German PMIs though – the slippage in the German Ifo suggests that it will take time for economic activity to bottom out. Driven by service providers close to manufacturing such as logistics, the business climate in the services sector soured from 21.3 in December to 18.7 in January (balance of optimists versus pessimists). Despite serious progress between the US and China, the risk of a trade war between the US and Europe still weighs on business sentiment in export-oriented Germany according to Ifo president Clemens Fuest. That China, which is among Germany’s most important trading partner, is grappling with the Coronavirus adds to that. Rising prices that reflect capacity constraints also dampen the outlook for the construction sector.
Now the good news: Business expectations among manufacturers rose for the fourth month in a row. The manufacturing sector is crucial for the German economy. It has been at the core of the Germany-led downturn in the Eurozone. A stabilisation in Germany’s most important sector of industry, the automotive sector, which continues to struggle amid some signs that the plight is easing, would be conducive to a rebound. It would further increase the chance that the domestically-oriented service providers would not be affected too much by the recent problems in manufacturing. After 0.1% qoq in Q4 2019 and Q1 2020, German growth could pick-up to its trend rate of 0.4% in H2 2020.
ITALY: DODGING A RISK
Italy’s right-wing firebrand Matteo Salvini is mobilising voters – but not only his own. Helped by a massive surge in voter participation by 30 points to 68%, the centre-left Democrats (PD) managed to hold on to their regional stronghold of Emilia Romagna in yesterday’s regional election with 51.4% for its candidate. This comes as a great relief to the left-of-centre government in Rome. It keeps the risk that the coalition between the 5Stars and the PD in Rome may disintegrate in 1H 2020 already at 30%. If Salvini’s Lega had won, the risk could have risen sharply. Except for Emilia Romagna, the Lega and/or its allies have scored victories at all other recent regional votes in Italy, including yesterday’s other vote in the smaller region of Calabria.
Despite the Emilia Romagna relief, the coalition in Rome is so beset by problems that it seems unlikely to serve out a full term until spring 2023. The risk of snap elections later in 2020 or 2021 remains elevated. The anti-establishment 5Stars seem to be in free fall. Having won the March 2018 national election with 32% of the vote, the 5Stars have now plunged to 16% in opinion polls. The vote for the 5Stars candidate in Emilia Romagna imploded to 3.5%, down from 13% in the previous regional vote in 2014. This should make the 5Stars even more eager to hold on to their positions in Rome instead of losing badly in potential snap elections. However, it also adds to the risk that the 5Stars may act irrationally out of despair and/or that further 5Star parliamentarians leave their party and thus deprive the Rome government of a majority in parliament, especially in the Senate.
While Italian politics will remain noisy, we expect the country to continue to muddle through for the time being. The real risk for Italy is the long-term: Neither the current government nor a potential new government led by Salvini looks likely to deliver the structural, administrative and legal reforms Italy needs to improve its dismal productivity growth in the next few years. Without such reforms, Italy would be a candidate for a debt crisis in the wake of a serious global downturn.
GREECE: VERY MUCH ON THE RIGHT TRACK
Some ten years after the start of its debt crisis in late 2009 and five years after the radical Tsipras/Varoufakis government brought Greece to the brink of financial collapse through a costly confrontation with creditors in the first half of 2015, Greece seems to have turned the corner for good. Fitch raised its rating for Greece’s sovereign debt last Friday by one notch to BB with a positive outlook. The rating is now only two notches away from investment grade, which could qualify Greek bonds for inclusion in the ECB’s asset purchase programme.
Under the conservative government of Kyriakos Mitsotakis, who came to power last July, Greece is pursuing the tax cuts and pro-business reforms which it needs to become a better place to invest and create jobs. The previous administration under Alexis Tsipras had also moved in the right direction since the closure of banks in mid-2015 had forced it to change tack. However, while Tsipras was widely seen as a reluctant and hesitant reformer, the Mitsotakis government is driving the ambitious reform agenda out of conviction. As a result, Greek economic sentiment has surged well beyond that of the Eurozone (see Chart 3 below). Against this backdrop, the government’s forecast for 2.8% growth for 2020 does not strike us as unrealistic.
Florian Hense
+44 20 3207 7859
Holger Schmieding
+44 7771 920377
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