What it means
The Ifo Institute surveys thousands of German companies every month in manufacturing, services, trade and construction. It asks two main questions: how are things now, and what do you expect over the next six months?
The answers are combined into a single index that is published once a month, usually towards the end of the month. The index is popular because it comes out quickly, well before official figures on output and growth are available.
Markets treat it as a leading indicator, meaning it tends to change before the wider economy does. A surprise move can shift currency, bond and share prices on the day of release.
The raw material is a balance. For each question, the share of firms giving a negative answer is subtracted from the share giving a positive answer, and the results are scaled against a base period set at 100.
Readings above the base suggest conditions are better than in that period, and readings below suggest worse. For a business manager outside Germany, the index is still useful.
Germany is a major buyer of goods from many countries, so a falling index may warn of weaker orders for exporters. A finance team planning sales forecasts for European customers can use it as one input alongside other surveys.
There are limits. The survey measures opinion, not hard results, and opinions can change quickly after news or a shock.
Analysts therefore compare it with other sources, such as purchasing managers' surveys and official output data, before drawing firm conclusions. The institute also publishes separate results for different sectors and for expectations alone.
A fall in the expectations reading while current conditions stay steady is often read as a sign that firms see trouble ahead, and it can be more telling than the headline number.
In practice
Real-world examples.
Example
A currency trader sees the monthly index fall further than economists expected. She reduces her holdings of euro-denominated assets before the announcement spreads through the market. Other traders do the same, and the euro weakens slightly.
Example
A machinery exporter in Italy sells heavily to German factories. Its finance director notes that the index has dropped for three months in a row and lowers the sales forecast for next quarter. She also asks the purchasing team to hold off on buying extra stock, which reduces the cash tied up in inventory.
Example
A retail investor reading a market commentary sees that the index has risen for the first time in half a year. He treats it as one sign that German companies are more confident but waits for hard data before changing his portfolio. A few weeks later, official figures confirm a modest improvement, and he adds a small position.
Formula
Calculation
Balance = % of firms answering positively - % of firms answering negatively
Suppose 1,000 firms are asked about their current business situation. If 350 say it is good, 500 say it is satisfactory and 150 say it is poor, then the positive share is 35% and the negative share is 15%. The balance is 35% - 15% = +20 points.
Next month the answers move to 250 good, 500 satisfactory and 250 poor. The balance becomes 25% - 25% = 0, a fall of 20 points. This kind of drop in the balance is what pushes the headline index down.Case study
Seen in the real world.
Rhine Components is a fictional supplier of car parts that sells half its output to German manufacturers. Its finance manager tracked the Ifo index alongside her own order book and noticed that the index had fallen for four months while orders were still strong.
Based on the pattern, she cut the planned production run for the next quarter by 10% and delayed a $400,000 equipment purchase. Two months later, orders from German customers began to slow.
In this illustrative case the early warning let the company avoid building up unsold stock, and the delayed purchase kept cash available. The manager continued to check the index each month, but treated it as one signal among several rather than a prediction.
Watch out
Common mistakes.
- Treating the index as a measure of actual output, when it is a survey of opinions and expectations.
- Reading a single month's move as a trend, when survey results can be noisy.
- Ignoring the difference between the current conditions and expectations components, which can move in different directions.
Questions
People also ask.
Where does the name Ifo come from?
It originates in the institute's German name, and today it is used as a brand in its own right.
How often is the Business Climate Index published?
It is released monthly and is based on surveys of German companies.
Why does it matter outside Germany?
Germany is a major trading partner for many countries, so changes in German confidence can affect demand, currencies and bond markets elsewhere.
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