Euro area: Ifo Current Conditions at New All-Time High

• The Ifo current conditions continue to increase to a new all-time high. This is much better than feared following yesterday's disappointing PMI data.
• The German Ifo expectations index decreased slightly, but still remains at a high level. This is in line with our expectations of strong German growth of 3.6% this year.
• Looking forward, we expect Ifo expectations to decline moderately. Our Ifo expectations model is clearly pointing down now.
• Today's release supports our expectation that the ECB will go ahead and deliver the July hike. However, if soft indicators deteriorate and energy prices stay low over the coming months, this could cause the ECB to postpone the third hike.

Ifo current conditions at highest level in 20 years

Ifo current conditions increased substantially from 121.4 to 123.3, which is much better than expected - especially taking yesterday's very poor PMI data into account. However, the only positive surprise in yesterday's figures was in fact the Germans service PMIs, see Flash Comment: Sharp drop in PMIs continues. The current condition index is at the highest level recorded. Expectations declined slightly from 107.4 to 106.3. This means that the aggregate Ifo business climate increased slightly to 114.5 from 114.2. Manufacturing expectations decreased further from 104.8 to 103.2 - which is in line with a soft patch in the global manufacturing cycle as also Chinese PMIs and US ISM shows.

Despite a drop in retail expectations from 117.7 to 113.8 the index remains high. Another positive aspect is also the increase in construction expectations, from 108.5 to 110.2 and in wholesale expectations, from 108.5 to 110.0. This is an early indication that German private consumption could be picking up. The German savings rate remains high so there is plenty of scope for increased private consumption. Despite Germany's strong growth, industrial production is still 5% below the pre-crisis top, so we do not expect any significant production capacity constraints. The global economy is currently faced with strong headwinds from the Japanese quake, fiscal consolidation and high energy prices in Q1. These pulls should weigh considerably on the German economy that is sensitive to the economic activity in its export markets. However, we have been expecting growth rotation as the recovery matures, and today's release indicates that we have got it.

Today's release is much better than expected. It actually suggests that our estimate of 3.6% GDP growth in Germany this year is on the low side. We thus stick to our expectations for the ECB to deliver the signalled July hike. However, if soft indicators deteriorate and energy prices stay low over the coming months, this could cause the ECB to postpone the hike from October.

Looking forward, we expect Ifo expectations to decline moderately. Our Ifo expectations model is clearly pointing down now and the OECD leading indicator is much more downbeat and signals that we could see a more notable decline in Ifo expectations. We also assess that current conditions are at a peak.