German and European Leading Indicators: ifo, ZEW, Bundesbank Reports and Flash Inflation

What you will learn

• How the ifo business climate is built from two balances with a geometric mean.
• How ZEW differs from ifo and why it reacts faster but is noisier.
• What the Bundesbank Monthly Report and the flash HICP add at month end.
• How to sequence the German and European calendar.

Explanation

For a euro investor the German and euro-area calendar matters as much as the US one for Bunds, the euro and the DAX. Its monthly order: ZEW around mid-month, flash purchasing managers' indices (lesson 5), ifo and the Bundesbank Monthly Report towards month end, then the flash inflation estimates for Germany and the euro area.

ifo Business Climate

The ifo Institute in Munich surveys around 9,000 firms in manufacturing, services, trade and construction. Each answers two core questions: is the current situation good, satisfactory or poor, and will business in the next six months be more favourable, unchanged or less favourable? Each gives a balance: positive share minus negative share, in points. Three series are published: current assessment, expectations and the headline business climate, a geometric mean of the two balances, shifted so that negative values can be handled:

climate balance = √[(S + 200) × (E + 200)] − 200

where S is the situation balance and E the expectations balance; the geometric mean punishes a large gap between the two. The published index is normalised to a 2015 average of 100 and seasonally adjusted. The ifo also quotes the three-times rule: a turning point is more credible after three consecutive moves in the same direction. Markets prefer the expectations component, because the situation component mostly confirms what GDP and industrial production (lessons 6 and 7) already showed.

ZEW Indicator of Economic Sentiment

The ZEW (Leibniz Centre for European Economic Research, Mannheim) asks about 300 financial analysts, not firms. The headline is the balance of analysts expecting the German economy to improve minus those expecting it to worsen over six months; a separate balance covers the current situation. Because analysts form views from market prices and news, ZEW moves earlier and more sharply than ifo and often overshoots. It is usually published on a Tuesday in mid-month, so it sets expectations for ifo. Good habit: note the ZEW surprise, then check whether ifo expectations confirm it.

Bundesbank Monthly Report

The Bundesbank's Monthly Report, usually in the third or fourth week, is not a market-moving number, but wording such as "the economy is likely to stagnate in the current quarter" is an informed nowcast, often quoted when the first GDP estimate arrives.

Flash inflation: Germany first, euro area next

Eurostat publishes the euro-area flash HICP (Harmonised Index of Consumer Prices) at the end of the reference month or on the first working day after it; the final figure follows about two weeks later. Destatis releases the German flash a day or two earlier, and that morning the federal states publish their own CPIs, so analysts can estimate the national number before the usual 14:00 release. Because Germany is the largest weight in the euro-area index, a German surprise changes the euro-area forecast the same day. Components and core measures were covered in lesson 2; the point here is timing: the flash arrives before the European Central Bank (ECB) meeting that reacts to it, so it carries more weight than the final print.

Worked example

Hypothetical example: an ifo release shows S = −10 and E = +5. Assumptions: balances seasonally adjusted; no normalisation to the 2015 index.

1. Climate balance = √[(−10 + 200) × (5 + 200)] − 200 = √(190 × 205) − 200 = √38,950 − 200.
2. √38,950 = 197.36; so climate balance = −2.6 points.
3. Check with the arithmetic mean: (−10 + 5) / 2 = −2.5. The geometric mean is lower because the two balances differ; the gap grows when they diverge strongly.

Earlier in the month, ZEW showed 40 % of analysts expecting improvement and 25 % deterioration: balance = 40 − 25 = +15; current situation 15 % good minus 55 % bad = −40. The ifo expectations balance of +5 confirms the direction but not the strength.

Flash inflation: suppose hypothetical euro-area HICP weights are country A 28 %, B 21 %, C 17 %, D 12 %, others 22 %, with annual inflation of 2.3 %, 1.9 %, 2.8 %, 1.6 % and 2.1 %. Weighted estimate = 0.644 + 0.399 + 0.476 + 0.192 + 0.462 = 2.17 %, about 2.2 %. If country A's flash comes in at 2.6 % instead of 2.3 %, the euro-area estimate rises by 0.28 × 0.3 = 0.08 points, enough to move a 2.2 % consensus to 2.3 %.

Common mistake

Practice activity

On paper: (a) An ifo release shows S = −20 and E = +12. Calculate the climate balance and compare it with the arithmetic mean. (b) Write the usual monthly order of: German flash CPI, euro-area flash HICP, ifo, ZEW, Bundesbank Monthly Report. (c) Country A (weight 28 %) reports flash inflation 0.5 points below consensus. By how much does the euro-area estimate change?

Key takeaways

• ifo combines situation and expectations through a geometric mean; expectations are the market-relevant part.
• ZEW surveys analysts, arrives first, moves more and is noisier.
• German flash CPI leads the euro-area flash HICP, which matters more than the final because it arrives before the ECB decides.

Next step

Next you look at the slower-moving but important housing and credit data: housing starts, mortgage applications, bank lending surveys and money supply.