Crisis clouds hang heavy over German economy

(FRANKFURT) - Exports and consumer demand are cushioning Germany against recession, data showed Thursday, but crisis clouds are gathering over Europe's biggest economy as business confidence fell sharply.

The German economy expanded by 0.5 percent in the first three months of 2012, the federal statistics office Destatis calculated, with a 1.7-percent rise in exports and a 0.4-percent rise in consumer spending helping to avert a recession.

But at the same time, the Ifo economic institute said its closely watched business climate index dropped to 106.9 points in May from 109.9 points in April.

The intensification of the Greek crisis and the resulting resurgence in uncertainty in the eurozone as a whole "is impacting the German economy," warned Ifo chief Hans-Werner Sinn.

It was the first time in seven months that the index has fallen and shows that companies are becoming increasingly spooked by the long-running eurozone debt crisis.

It was in fact the steepest drop since August last year and brings the barometer down to its lowest level since November 2011.

Companies' assessment of their current business situation "deteriorated clearly and they also expressed greater pessimism about their business outlook," said Sinn.

Economy minister Philipp Roesler was adamant, however, that despite the unexpected drop in the Ifo index, businesses "remain confident."

The German economy "grew unexpectedly rapidly in the first quarter and is now clearly back on a growth path," he said.

"Even in these difficult times, the economy remains robust and competitive. It continues to be the growth locomotive in Europe," the minister insisted.

Observers elsewhere were not so sure.

Already on Wednesday, the Bundesbank warned in its May monthly report that the "surprisingly good GDP data" for the first quarter "overstate the current underlying cyclical trend and cannot be extrapolated onto the following quarters."

And analysts, too, forecast that German growth will taper off in the coming quarters.

"Risks to growth in the second half of this year have increased and uncertainty concerning Greece and possible spill-overs are currently dampening expectations," said Natixis economist Constantin Wirschke.

Annalisa Piazza at Newedge Strategy agreed.

While the first-quarter data "confirm that the German economy held up well at the start of the year... the breakdown of the data shows a mixed picture" and future risks were "skewed to the downside," Piazza said.

Voices at Germany's economic base, too, appear to becoming more cautious.

For its survey, Ifo quizzes around 7,000 companies about their current business situation and the outlook for the next six months and, according to the survey data, the sub-index measuring current business is now at ts lowest level since July 2010.

ING Belgium economist Carsten Brzeski saw the Ifo survey as a sign of a "new realism" on the part of German businesses.

"For last couple of months, it had seemed that the Ifo index painted a too positive growth picture. Today's Ifo reading has corrected this picture in one fell swoop," Brzeski said.

"German businesses have woken up to reality: islands of happiness might exist, economic islands within the eurozone hardly," he said.

The Ifo survey was released at the same time as a key eurozone confidence index, the Purchasing Managers Index (PMI) compiled by the London-based research firm Markit, which suffered its worst monthly slide in nearly three years in May.

Both sets of data combined "confirm the picture of falling economic activity in the eurozone as a whole and suggest that the downturn has now really hit Germany," said Capital Economics economist Jennifer McKeown.

But UniCredit economist Andreas Rees warned against reading too much into the Ifo data.

"Undoubtedly, the signs are mounting that, at least temporarily, some softer momentum in the German economy is underway," he said.

"However, it would be outright wrong to ring the death bell for the German economy" at this point, he argued.

Rees saw the drop in sentiment as a result of "psychological fears of Greece leaving the eurozone with all the uncertainties and unknown quantities involved" and that the weaker euro and falling oil prices would work in Germany's favour in the longer run.

Christian Schulz at Berenberg Bank similarly believed that the current level of the Ifo index "suggests continued growth, albeit at a much lower level than recently."