Crisis clouds gather 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 falls sharply.

The German economy grew 0.5 percent in the first three months of 2012, the federal statistics office Destatis said, with a 1.7-percent rise in exports and a 0.4-percent gain 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 in May, with the intensification of the Greek crisis and the resulting resurgence in uncertainty in the eurozone as a whole "impacting the German economy."

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

The drop was also the steepest drop since August last year and, at 106.9 points, brings the barometer down to its lowest level since November 2011.

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.

On Wednesday, the Bundesbank had warned in its May monthly report that the "surprisingly good" first quarter growth figures "overstate the current underlying cyclical trend and cannot be extrapolated onto the following quarters."

Analysts said they shared that view that German growth will taper off.

"The German economic recovery has hit a fresh road-block that is most likely linked to fears about disruptions due to the eurozone debt crisis," said IHS Global Insight economist Timo Klein.

"Germany's economy appears to have weakened markedly during the second quarter but not necessarily to the point that ... growth has turned negative," Klein said.

Historically low interest rates, persistently strong employment and wage growth, and fairly subdued euro levels should provide some support, he argued.

Annalisa Piazza at Newedge Strategy said that 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."

At Germany's economic base, there were more cautious voices too.

For its survey, Ifo quizzes around 7,000 companies about their current business situation and the outlook for the next six months. According to the survey data, the sub-index measuring current business confidence is now at its 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 the 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 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.