There was nothing to cheer about in the latest readings of business confidence in Germany. The Purchasing Managers’ Index (PMI) from IHS/Markit moved into recessionary territory in September. Sentiment in the manufacturing sector declined to 41.4, which is the lowest level since mid-2009, at the depth of the financial crisis.
Same message came from the broader Ifo-index; expectations are down to levels last seen in 2009, while the assessment of the current situation is at par with the euro crisis in 2012. Confidence in the construction sector is also waning, and even retail – the last hope for consumer-driven growth – is losing altitude.
The Economic Sentiment Index (ESI) from the EU Commission dropped to the lowest level since 2013. The ESI-indicator covers every corner of the economy and tells the same story as Ifo and PMI: lower confidence in manufacturing, construction and retail. Slightly higher than in August for services and consumers, but the levels remain significantly lower than before the summer.
Auto producers remain central problem
The auto sector remains the most challenged part of the German manufacturing sector, but lately the decline in actual new orders has primarily been concentrated in intermediate and investment goods. Naturally, this could also be auto related as many sectors in Germany are part or service suppliers to auto producers.
Measured by value-added, activity in the manufacturing sector has declined for more than a year with no end in sight. Orders are now completed faster than new orders arrive, thus idling production facilities. Employment in the manufacturing sector has stayed strong as the use of kurz arbeit – the shortening of work hours with supplementary benefits – has expanded. However, a reduction in manufacturing employment is likely to commence. The business-to-business service sector is already losing jobs.
Services also affected
The service sector has been a somewhat overlooked positive in the German economy and generated 325,000 jobs in the last year alone. Over the last ten years, employment in services has risen by 3.65 million, while manufacturing has created 0.53 million jobs. Consumer-oriented services of trade, transport, accommodation and food services have been the main driver of new service jobs.
However, the decline in service-sector confidence indicators since spring increases the risk of a prolonged downturn in activity in the broader economy. That could lead to rising unemployment, which – in turn – would amplify the call for the government to do more to stimulate the economy.
France is looking better
Business sentiment also declined in other euro area countries in September, although less than in Germany. Overall, manufacturing is contracting, while services are expanding at a modest pace. France remains a positive outlier with growth in both manufacturing and services. Businesses continues to report increasing orders and backlogs of work. This bodes well for future production. French firms are also optimistic about the business outlook; they became even more optimistic in September, despite the gloom in Germany.
Corporate investments have been a potent driver of economic growth in recent years amid President Macron’s many reforms. Since the Brexit referendum in the UK in June 2016, corporate investments have declined in the UK, grown by 10 percent in Germany and by 13 percent in France.
Risks remain to the downside
The outlook for the global economy remains gloomy. The trade war between the US and China is taking its toll on both economies, although China has been hit the hardest so far. The US manufacturing sector is hurting, but not more than producers elsewhere. The tax cuts from 2017 are still supporting the bottom line. US consumers remain optimistic, and the reduction in interest rates since start of the year is supporting both consumers and the housing market. The US economy should overperform expectations in coming months.
Germany has become collateral damage in the trade war, which has been amplified by unique events like the diesel scandal and the drying up of German rivers – a main artery for transportation of industrial goods – two summers in a row. But there is also a glut in the global auto sector; auto sales have been a driver of overall economic growth in many countries but are no longer growing. The global manufacturing sector had geared up for a period of high growth and is now adjusting to a new reality. This is hurting investments.
Moreover, the economic policy uncertainty has never been higher. President Trump in Washington and Prime Minister Johnson in London have taken “disruption” to unprecedented levels. The investigation into the possible impeachment of President Trump has killed off any hope of major policy deals ahead of the 2020 election. Congressional approval of the updated Nafta-agreement with Mexico and Canada looks even more uncertain than before. The upcoming ruling by the World Trade Organization in the US/EU dispute about subsidies to Airbus and Boeing could hand President Trump the opportunity to start a trade war with the EU.
China is slowing, and doubts about the ability to counter the slowdown are increasing. The new government in Italy has reduced the risk of a showdown with Brussels in coming months, but there is no ambition to tackle Italy’s fundamental problems, and the economic as well as the debt outlook is unsustainable. Argentina is approaching another government default, and Turkey is mired in recession.
Business are unlikely to move ahead with major investment plans in the current economic climate.
What can be done?
The economic malaise in Germany is likely to continue in the short run. The European Central Bank (ECB) has already used its last firepower to no avail. Negative interest rates could be hurting growth in Europe as savers are punished.
On paper, Germany has the fiscal muscle to do something to counter a downturn. There has been a surplus in the public accounts since 2014 and the public debt is finally below 60 percent of GDP. And Germany needs major investments in infrastructure and not least digitalization. But it is doubtful tax cuts would work much as households have mostly used the growth in real income to increase savings.
Public investments are no longer a good counter-cyclical tool as the pre-construction phase for planning, environmental assessments, procurement, etc., is quite long. Moreover, Germany still has full employment, so adding to construction activity is likely to push cost up further, thus squeezing out private activity. The new EUR54 billion climate-change package is not likely to produce much additional economic activity.
Rising unemployment could change the political environment and allow for more government action, but probably not until next year.
My main scenario remains that easier global monetary policy and a completion of the adjustment in the manufacturing sector should add support to global growth next year. But no amount of monetary stimulus can counter the damage from a further escalation of “disruption”.