Have the leading indicators passed their peak for the economic cycle?

The year 2017 was very successful for the Euroland economy. With economic growth of 2.5 percent on the prior year, the performance was the best since 2007. This economic strength is reflected in the typical survey-based leading indicators. They started to soar at the latest as of second-half 2016 and ultimately may have slightly exaggerated the actual growth momentum.

They include firstly the indicator for so-called economic confidence. The EU Commission determines this figure for all EU and EMU member states on the basis of national surveys in the industrial, service, construction, retail and consumer sectors and then condenses it to form a barometer of economic confidence. Secondly, they include the PMIs which are compiled by private survey institute IHS Markit and reflect the sentiment in large service and manufacturing corporations.

In early 2018, these two sentiment yardsticks slipped slightly from their highs and the level posted in December 2017 appears to have marked their zenith. If this is the case, then we must expect news on dwindling EMU economic sentiment in the coming months. What does this mean for Euroland’s economic prospects?

To put it clearly, economic growth would then not suddenly shudder to a halt. A significantly slower pace to growth is not to be expected. This is also reflected in our economic forecast for Euroland. We expect the current year to see growth in gross domestic product of 2.3 percent on the year, which is only slightly weaker than the previous year.

What applies to the EMU is also evidenced by the key leading indicators for Germany. The ifo business climate index as the most important sentiment barometer for corporate Germany hit an all-time high in November 2017 and then again in January 2018 of 117.6 index points, mainly thanks to an extraordinarily good assessment of the current situation. Business sentiment has of late not been able to maintain that level. While the evaluation of the current situation has only dipped slightly, business expectations clearly sagged in February.

Sentiment among private households did not improve either. Since September 2017 it has been lodged at a level just short of 11 index points, meaning that consumer sentiment is still at a high level. The overall clear improvement in German sentiment indicators will presumably now be followed by a correction phase, which is still consistent with continued growth.

The weakening in the leading indicators for Euroland as a whole and for Germany as well is therefore not especially disquieting. The current upturn, which has now persisted in Euroland for more than four years, continually picked up speed. With growth having been strong of late, it is getting increasingly difficult to step up the pace even further. And that can now also be seen in the leading indicators. However, this does not mean that the upturn will suddenly come to an end. The sentiment indicators would have to fall faster and more significantly for that to be the case. The latest decreases are rather the result of the very high level and not attributable to economic activity dimming. Moreover, important key global economic drivers remain intact.

Thus, in the US for example, sentiment indicators for business and consumers alike have continued to climb. In February, consumer sentiment (Conference Board) hit a 17-year high and the upward trend for industrial sentiment is likewise still intact. In the US, however, the recent tax cuts have been an additional economic stimulus. We accordingly expect that the US economy will post 2.5 percent growth this year, which is slightly higher than the momentum of the prior year.


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