More evidence of a German economic slowdown is building the case for a European Central Bank interest rate cut next week.
On Wednesday, the Ifo index, Germany's most closely watched indicator of business expectations, recorded its sharpest drop since May, 2012. It went to 104.4 from last month's 106.7. Economists had predicted a far smaller decline.
The weak Ifo number came a day after Markit's purchasing managers index for euro zone manufacturing hit a four-month low in April. The same index showed a sharp drop in German business activity that month.
The mounting evidence of a German and broader euro zone slowdown has raised expectations for an ECB rate cut on May 2, when its governing council is to meet in Bratislava, Slovakia. The last rate cut came in July, 2012.
In a note published this morning, Deutsche Bank economists Gilles Moec said Mark Wall said they expected a 0.25 per cent rate cut, which would take the refinancing rate to 0.50 per cent. "With only 75 [basis points] of refi rate potential before hitting the zero nominal bound, we think the Council is likely to favour two quarter point cuts, on in May and another to follow in the summer," they said.
The euro fell when the Ifo data was released, then rose marginally. The European stock markets rose on the expectation of rate cut.
The signs of weakness in European manufacturing, and also American and Chinese manufacturing, suggest the European and global economies will have trouble picking up momentum in the second quarter. ECB president Mario Draghi on April 19 said the latest euro zone economic data showed no improvement. He hinted earlier that he might cut interest rates if the touted recovery proved elusive.
The 17-country euro zone remains in recession. The ECB predicts a 0.5-per-cent reduction in the region's gross domestic product this year. The International Monetary Fund expects the euro zone to shrink by 0.3 per cent. Italy, which has been unable to form a government after February's inconclusive elections, is in deep recession and Spain's central bank on Tuesday estimated the economy shrank by 0.5 per cent in the first quarter.
The Bundesbank, Germany's central bank, expects German growth of only 0.4 per cent this year, though the figure could prove inaccurate.
"Looking ahead, it almost requires a fog lamp to predict the future path of the Germany economy," said ING economist Carsten Brzeski. "Available hard and soft data send a huddle of indications. Order books are gradually filling and inventory reductions have come to an end, while at the same time confidence indicators have started to fall again."
Few economists think a quarter-point rate cut by the ECB will kick-start the ailing economies. But it may help exporters by putting downward pressure on the €. "Particularly, a weaker euro would be a welcome relief for German exporters," Mr. Brzeski said.