German business and consumer morale hit multi-year lows as confirmation came on Tuesday that Europe's biggest economy shrank in the second quarter, raising the risk that the country could fall into recession. The Munich-based Ifo think tank said its key business climate index for August fell to its weakest since June 2005 as the fallout from the global credit crisis further chokes off economic activity.
This dealt a second blow to Germany's prospects after the GfK market research group's forward-looking indicator earlier showed consumer sentiment fell to a new 5-year low going into September on worries about the economic outlook. "A hard landing is certain. Even a crash landing - that's to say a recession - can't be ruled out anymore," said Commerzbank analyst Joerg Kraemer. Antje Hansen at HSBC Trinkaus agreed: "The probability of a recession has risen."
The Ifo business climate index, based on a monthly poll of some 7,000 firms, fell to 94.8 from 97.5 in July. The deterioration was much sharper than the forecast level of 97.1 and the news sent the euro to a fresh six-month low below $1.46.
"The new fall in the Ifo business sentiment index should support expectations that the European Central Bank won't carry out further interest rate increases," said Ulrich Wortberg, analyst at investment house Helaba. The ECB left interest rates unchanged earlier this month and said inflation was still its key fear even though risks to growth were taking hold. This may change, economists said. "With abating inflationary pressures, we expect the ECB to shift its main focus towards the bleak growth outlook soon," said Carsten Brzeski at ING.
The Federal Statistics Office confirmed earlier that gross domestic product (GDP) contracted by 0.5 percentage points on the quarter in the April-June period. The contraction was Germany's first since 2004. A recession is commonly defined as two or more consecutive quarters of negative growth. A number of leading economists have said the economy could contract again in the third quarter.
Consumer spending shaved 0.4 percentage points from the growth total in the second quarter, as did capital investment. Ifo said retailers' expectations for the coming six months had deteriorated from its previous survey. Germans' retail habits are key to the overall economy's performance as consumer spending accounts for over half of GDP.
Earlier this month, retailer Arcandor lowered its earnings outlook as losses at its department stores widened. The GfK sentiment indicator, based on a survey of 2,000 Germans, fell to its lowest since June 2003.
"The weak economic outlook is choking consumption," said GfK analyst Rolf Buerkl. On a more positive note, the Federal Statistics Office said Germany posted a budget surplus in the first half of 2008 equating to 0.5 percent of GDP. However, the news highlighted the divisions on economic policy within the ruling coalition. Economy Minister Michael Glos, a conservative, said the pick-up suggested there was more room for tax cuts - an idea opposed by Finance Minister Peer Steinbrueck, a Social Democrat.
The Ifo index's decline was below the Reuters consensus poll forecast for a drop to 97.1. Only one economist surveyed predicted an Ifo reading below the outcome of 94.8. The fall in August followed a decline in July and the two-month drop was the sharpest since reunification in 1990.
"The German economy is encountering an increasingly difficult situation," Ifo President Hans-Werner Sinn said in a statement, adding that companies saw a weaker export outlook and would take a more cautious approach to hiring new staff. An Ifo component index on manufacturing fell to -6.8 from 2.0 in July, dropping to its lowest level since July 2003. The survey's expectations component fell to 87.0 from 89.9 in July, hitting its lowest level since February 1993.
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