Can Germany’s improving financial sentiment beat business pessimism?

Financial experts are more optimistic about Germany’s economy as the ZEW index rebounded more than expected in December, its highest in four months, driven by ECB rate cut prospects and snap elections. Yet, the ifo survey shows businesses remain far more pessimistic about 2025.

Financial experts’ confidence in the German and Eurozone economies improved in December, buoyed by the European Central Bank’s interest rate cut and expectations of economic policy shifts following Germany’s upcoming snap elections.

The ZEW Economic Sentiment Index for Germany, which reflects financial experts’ six-month outlook, rose sharply to 15.7 points in December, up from 7.4 points in November, exceeding market forecasts of 6.5 points. This marks the index’s highest reading in four months, as analysts anticipate pro-investment policies and further ECB rate cuts to support economic recovery.

However, the optimism was tempered by worsening assessments of the present economic environment. The sub index measuring current conditions fell further into negative territory, dropping to -93.1 points, its lowest level since May 2020.

ZEW President Achim Wambach highlighted the factors driving the improved outlook. “With snap elections ahead in Germany and the resulting expectations of an economic policy encouraging private investment, as well as the prospect of further interest rate cuts, the economic outlook is improving. Our daily analyses also show that after the meeting of the European Central Bank’s Governing Council on 12 December, experts still expect further interest rate cuts for the coming year.”

On Monday, German Chancellor Olaf Scholz lost a vote of no confidence on Monday, triggering early elections scheduled for February. The country’s governing coalition fell apart last month due to a heated disagreement over the national budget.

Across the eurozone, financial experts’ optimism similarly improved. The ZEW Economic Sentiment Index for the euro area climbed to 17 points in December, up from 12.5 points in November, surpassing estimates of 12 points. Yet, the eurozone’s current situation indicator fell by 11.2 points to -55.0, highlighting ongoing economic struggles.

In December’s ZEW survey, Information Technology and Services sectord stood out with strong expectations for improvement, while sectors like Chemicals/Pharmaceuticals and Steel faced a more pessimistic outlook.

The weaker sentiment in these sectors could reflect concerns over rising global trade tensions, including the risk of potential Trump tariffs being introduced next year, which may disproportionately impact export-dependent industries like chemicals and steel.

ifo survey paints a bleaker business outlook

While financial experts surveyed by ZEW foresee improving conditions, the latest ifo Business Climate Index reveals a more pessimistic sentiment among German businesses.

The ifo index fell to 84.7 points in December, down from 85.6 points in November, marking its lowest reading since May 2020 and falling short of economic forecasts.

The ifo subindex for current business conditions showed modest improvement, rising from 84.3 points to 85.1 points, slightly above expectations of 84 points.

However, business expectations for the months ahead plunged to 84.4 points, down from a revised 87 points in November, marking their lowest level since February 2024.

ZEW vs ifo: Financial sentiment versus business reality

The divergence between ZEW and ifo results reflects their differing methodologies and focuses. The ZEW Economic Sentiment Index measures the outlook of financial experts, who assess macroeconomic trends, monetary policy, and global market dynamics. This makes ZEW particularly sensitive to expectations of interest rate cuts and political changes, such as the snap elections in Germany.

In contrast, the ifo Business Climate Index surveys German businesses across industries, providing a more grounded perspective on current economic activity and future expectations. Businesses tend to react more directly to immediate operational challenges, such as weak demand, global competitiveness concerns, and rising input costs.

While financial experts appear cautiously optimistic, businesses remain far more pessimistic about Germany’s economic prospects heading into 2025.

Stagflation risks persist as experts urge ECB caution

ZEW economist Friedrich Heinemann expressed concerns over inflationary pressures and trade risks in the aftermath of the US presidential election.

“It is good that the ECB Governing Council has refrained from making a major interest rate move. The ongoing wage pressure and high inflation in services prove that the wage-price spiral is still turning. Even more serious is that the risk of imported inflation has now grown since the US presidential election. If tariffs increase on both sides in US-Europe trade, this will drive up import prices. Germany must therefore expect continued stagflation next year, with mini-growth and excessive inflation.”

Heinemann emphasised that the European Central Bank must communicate carefully to signal that further rate cuts are not guaranteed, as premature easing could exacerbate inflationary risks.

Financial optimism vs business reality: Can Germany bridge the confidence gap?

Germany’s economic sentiment offers a tale of two perspectives.

While financial experts remain optimistic about pro-investment policies following snap elections and the prospect of further ECB interest rate cuts, German businesses surveyed by the ifo institute reflect a far grimmer outlook for 2025, as immediate challenges like weak demand, inflationary pressures, and trade uncertainties persist.

The German stock market appears more aligned with the optimism of financial experts, as the DAX index hovers near record highs, surging 22% year-to-date – its best performance since 2019 – despite an economy on track for stagnant growth this year.

The contrast between improving financial sentiment and cautious business confidence highlights both the hopes for recovery and the structural issues that continue to constrain Europe’s largest economy.