Sound bites: German ZEW economic sentiment collapses to 36.3 in April from 48.5 in March

The chickens are coming home to roost for economic confidence in Germany. This is being foreshadowed by a dramatic collapse in Germany’s ZEW index. The problems are starting to pile up for business, with the debt crisis in Cyprus, the Eurozone recession and the slowdown in China all taking a greater toll on sentiment. Last month, problems in Cyprus were only just beginning to make their mark, but this month the impact is much more apparent. In recent months, there has been a growing confidence that German business could shrug off the downside risks and rely upon faster export performance to pull the economy away from the rocks of recession. This looks increasingly misplaced as it will be impossible for Germany to decouple from the problems besetting the Eurozone and the increased risks of slowdown in the global economy.

This has important consequences for the German outlook. If business confidence is peaking, German companies are going to be far less optimistic about output intentions, new investment and new hiring. It means that domestic demand is not out of the woods and recession risks are still just as acute for Germany this year and possibly next. The deepening cost of the Cyprus bail-out underlines that there is more bad news to play out for the Eurozone debt crisis. While the Eurozone remains subsumed by recession forces, it’s not only an on-going risk for the troubled Eurozone periphery countries, but for the German economy as well. Germany’s economic fortunes are inextricably bound up with the fate of the Eurozone. Right now, this remains deeply troubled. The bottom line message for Eurozone policy is that greater economic stimulus is the only way forwards.

Budget policy must be much more forgiving given the dire economic outlook. Policy must switch from austerity towards pro-growth fiscal reflation. At the same time, the ECB needs to follow the same path adopted by the US Federal Reserve, the Bank of Japan and the Bank of England, to crank up the gears of recovery in the Eurozone with monetary reflation. At some stage, the ECB will have their epiphany and realise that the only way forward will be unremitting quantitative easing to get the Eurozone economy out of jail and onto a much firmer recovery track.

While the euro is enjoying a moment of relief the outlook remains deeply negative for the currency once the ECB opens up the monetary floodgates again. A return to USD1.20 territory looks increasingly obvious.