The subdued trend in new orders but, even more, the sharp deterioration in business expectations in the Ifo test have stoked concerns that Germany is on the brink of a recession.
The manufacturing industry remains the sector most sensitive to economic ups and downs and, in the short term, has the greatest impact on GDP growth. Precisely for this sector, the Ifo test provides a host of detailed survey results (business situation, business expectations, demand situation, order books, finished goods inventories, production, production plans). Using a straightforward regression approach, we have examined the explanatory content and the time-lead of the Ifo survey results with regard to trends in industrial production. As the monthly production figures and the Ifo survey results are fairly volatile, we have used three-month moving averages and in the projection highlight the 3-month change in smoothed industrial production based on a corresponding change in the Ifo indicator.
All Ifo test indicators are highly significant and, in the respective best projection, display a lead of one (business situation, assessment of new orders, assessment of finished goods inventories) to three months (business expectations, production plans) compared with the trend in industrial production. The explanatory share of the various indicators ranges from 35% (business expectations) to 70% (business situation).
Indicators with a lead of only one month are of only limited value as a leading indicator of economic trends, even if their explanatory content is fairly good, as is the case with the assessment of the business situation. We therefore focus on business expectations and production plans, with their lead of three months. Their explanatory content can be further improved by including in the projection not only the changes in the Ifo indicator but also its level. The changes in production plans over three months and the level of production plans over two months explain a hefty 75% of the changes in industrial production.
However, currently (Q3 2014) this approach flags up a significantly better performance in industrial production than has materialized. This suggests that, of late, productions plans have been adapted to weakening business activity more swiftly than usual.
With today’s release we now have industrial production figures up to September, the Ifo test results are available up to October, enabling us to project the change in industrial production up until December.Compared with the estimated third quarter figure, this shows a drop in production of more than 1% for the fourth quarter. However, compared with the actual production level in the third quarter, the drop in industrial production is likely to be very small. This is likely to be offset by rising output in most other sectors. As a result, we estimate that gross domestic product will at least stagnate in the fourth quarter, possibly even increase slightly.
Early next year the economic picture will probably brighten up markedly, with the upward forces likely to regain the upper hand. Lower commodity prices, increased purchasing power and the exchange rate-induced boost to price competitiveness will provide a substantial lift.