Originally created 06/26/04

Germany's Ifo index of business sentiment drops in June



FRANKFURT, Germany -- A widely-watched indicator of business sentiment in Germany dropped unexpectedly in June in an unsettling sign for Europe's biggest economy.

The Ifo Institute said Friday its index of business sentiment fell to 94.6 from 96.0 in May. Ifo Institute head Hans-Werner Sinn said that while the drop was a letdown he still expected Germany to experience a moderate recovery later this year.

"It's a disappointment for everyone, we expected, really, an increase in the indicator," Sinn said on CNBC Europe television. "Let's wait another two months to make a real assessment."

The index fell across all four sectors in which executives were surveyed: manufacturing, construction, wholesale and retail. Their assessment of current conditions dropped to 93.2 from 94.4 in May, and the outlook for the future fell to 96.0 from 97.7.

It was the second straight monthly drop; the institute says it takes at least three straight months up or down to establish a clear trend.

Sinn said the results were "not a catastrophe, we should not overdo it... There still is a business upswing."

"I am still mildly optimistic that we get decent growth this year in Germany, not enough growth to be really happy about it but we do expect substantial growth," he said.

Most economists expect the German economy to pick up this year after shrinking 0.1 percent in 2003, the third straight year of stagnation. But many expect the recovery to be modest at best, with the government forecasting 1.5 to 2 percent growth for all of this year.

And, with Europe-wide growth picking up, Germany can't look to the European Central Bank for a growth-boosting interest rate cut. France, which together with Germany makes up about half of the economy for the 12 countries using the euro currency, showed 0.8 percent growth in the first quarter compared to quarter before, double Germany's 0.4 percent.

The bank, which must decide rates for the entire euro zone, not individual countries, appears set with its main refinancing rate at 2 percent because a cut could worsen inflation, which can be a side effect of growth.

German exports are benefiting from stronger demand in the United States and Asia, where the economies are growing faster. But demand at home remains weak, with consumers unsettled by high unemployment and growing budget deficits and therefore lacking confidence to spend freely.

Export growth isn't creating more jobs and consumer spending at home because much of Germany's industrial production for export has been relocated to lower-wage countries in eastern Europe, said economist Andreas Rees at HVB Group in Munich. "Major parts of industrial activity do not take place in Germany but abroad," Rees said. "I think this is weighing on German economic activity."

He said the Ifo drop "indicates we will see a cooling off of the German economy in the second half of the year." HVB's forecast - one of the most pessimistic in Germany - sees growth of only 0.9 percent.

Economists say that under the best circumstances the recovery expected this year and next won't be strong enough to cut into Germany's chronically high unemployment rate, now 10.3 percent.

The Ifo index, based on a survey of executives at 7,000 companies about their views of the current and future business climate, is a leading indicator, meaning it suggests where the economy may be going in the months ahead.