German Recession Looms as Business, Consumer Confidence Drop

By Simone Meier

Aug. 26 (Bloomberg) -- German business and consumer confidence fell more than economists forecast, heightening concern that Europe's largest economy may be slipping into a recession.

The Munich-based Ifo institute's business climate index, based on a survey of 7,000 executives, dropped to a three-year low of 94.8 from 97.5 in July. Consumer sentiment slumped to the lowest level in five years, according to Nuremberg-based market research company GfK AG. The euro and bond yields fell.

Germany's economy contracted in the second quarter and may fail to grow in the third. While oil prices have receded from a record $147.27 a barrel, they're still up 60 percent over the past year, crimping companies' spending power just as the euro's appreciation and the U.S. housing slump weigh on exports.

``The economy will barely grow in the third quarter,'' said Gregor Eder, an economist at Dresdner Bank AG in Frankfurt. ``If oil prices remain at the current level or increase, we wouldn't be able to avoid a recession in Germany.''

Ifo's gauge of business expectations dropped to 87, the lowest since February 1993, when Germany was experiencing the worst recession of the past two decades. A measure of current conditions eased to 103.2 from 105.7.

The economy contracted 0.5 percent in the three months through June as construction slumped and companies and households reduced spending, the Federal Statistics Office confirmed today. Exports also fell.

The euro dropped more than a cent after the Ifo report to $1.4597 and yields on 10-year German bonds fell 5 basis points.

ECB Rates

The chances of the European Central Bank cutting interest rates are growing, Ifo economist Gernot Nerb said. The ECB last month raised its key rate by 25 basis points to 4.25 percent to fight inflation.

The rate increase ``was certainly not helpful,'' Nerb said in an interview with Bloomberg Television. ``In the current environment, it would be better if they'' lowered borrowing costs. ``It's difficult to say whether the worst is behind us.''

Investors raised bets that the ECB's next move will be a rate reduction, Eonia forward contracts show. The yield on the March contract fell to 4.11 percent today from 4.61 percent on July 21.

While the German government has maintained its forecast for growth of 1.7 percent this year after 2.5 percent in 2007, the Berlin-based BDB banking association said on Aug. 20 the economy may barely expand in the second half of the year.

Oil, Euro

Arcandor AG, Germany's largest department-store operator, on Aug. 13 reported a loss for the quarter through June and reduced its 2009 earnings forecast. Daimler AG, the world's second-largest luxury carmaker, said Aug. 6 it plans to cut production by 45,000 vehicles by the end of the year. The Stuttgart-based company had already lowered its full-year earnings forecast.

In the economy of the 15 euro nations, manufacturing and service industries contracted for a third straight month in August and confidence in the economic outlook last month dropped the most since the Sept. 11 terrorist attacks in 2001.

The price of crude has dropped 9 percent over the past month to around $114 a barrel and the euro has retreated from an all- time high of $1.6038 on July 15. Some companies are also benefiting from demand in faster-growing economies in Asia and eastern Europe.

Hochtief AG, Germany's largest builder, on Aug. 14 raised its full-year earnings forecasts on increasing demand for construction and mining work. SAP AG, the world's largest maker of business- management software, last month raised its full-year earnings forecast on increasing orders.

Still, ``the airbag effect of lower oil prices and a weaker exchange rate hasn't kicked in,'' said Andreas Rees, chief German economist at UniCredit Markets & Investment Banking in Munich. ``We see a recession risk of 70 percent this year.''

To contact the reporter on this story: Simone Meier in Frankfurt at smeier@bloomberg.net