German investor sentiment plunged in August to its lowest level in over five years as a looming rise in sales tax, high oil prices and a strong euro clouded the outlook for Europe's largest economy.
The Mannheim-based ZEW economic research institute said on Tuesday its economic expectations indicator for Germany, based on a survey of 307 analysts and institutional investors, fell to -5.6 from 15.1 in July.
It was the lowest reading since June 2001 and the seventh consecutive drop in the closely-watched figure. Economists polled by Reuters had expected 12.0.
Together with an unexpectedly large 2.5 percent drop in eurozone June industrial orders, the data provoked questions about the durability of a European recovery that has surprised many with its recent vigour.
"It is double trouble for the euro zone economy," said David Brown, economist at Bear Stearns in London. "The German ZEW index has fallen off a cliff since the start of the year."
ZEW said its survey pointed to a "considerable economic downturn" over the next six months. "The main reasons for this are that exports, investment spending and consumption might decrease," it said.
Some economists cautioned against reading too much into the precipitous drop in the index, noting the volatility of the ZEW figure and recent strong growth and job creation data. "The ZEW is the kind of indicator which tends to predict 10 out of 5 recessions (or upswings)," said Holger Schmieding at Bank of America.
Many will wait for the Ifo think tank's business climate index on Thursday before passing judgement. Economists polled by Reuters expect that index to slip to 104.8 in August from 105.6 last month.
"We shouldn't get too carried away with this number," said Adolf Rosenstock of Nomura International. "Don't forget that it follows some very good economic data."
Schmieding said the poor ZEW was unlikely to stop the European Central Bank (ECB) tightening borrowing costs again.
"We maintain our call for two further 25 basis-point rate hikes in October and December 2006, followed by a long period of stable rates at 3.5 percent in 2007," Schmieding said. The ECB has raised rates four times since December.
The German economy sprang into life in the second quarter, growing at 0.9 percent, the strongest rate in over five years. Unemployment has declined steadily over the past year and domestic demand, long sluggish, has shown signs of picking up.
News from German firms has also been positive.
Of the 30 companies in Germany's blue chip DAX index, 10 raised full-year earnings forecasts when reporting results for the quarter to end-June. Only three cut them.
But high oil prices, slower US growth and a robust euro are all seen as risks to the outlook and have weighed on investor sentiment. Economists say a planned 3 percentage point hike in value-added tax (VAT) in 2007 could choke off a recovery which is expected to see the fastest German economic growth for six years in 2006.
ZEW President Wolfgang Franz described sentiment for 2006 as "sunny" but warned of "dark clouds" on the horizon in 2007, once the VAT increase takes effect.
German construction orders data for June, also released on Tuesday, showed orders rose for the eighth straight month, but recorded their weakest rate of growth this year. The building sector helped fuel Germany's strong second quarter. A separate ZEW gauge of current conditions for Germany rose to 33.6 from 23.3 in July, better than a consensus for 26.5. A gauge of euro zone expectations fell sharply to 1.3 from 18.1. The ZEW survey was conducted between July 31 and August 21.