German ZEW investor confidence survey drops sharply

The ZEW institute said its closely watched indicator of economic sentiment for June fell by a much sharper-than-expected 11.0 points to minus 52.4 points. Economists polled by Dow Jones Newswires had expected a much more gentle decline of less than one point to about minus 42 points.

"On the one hand, repeatedly decreasing incoming orders indicate that Germany's momentum will lose steam in the next six months. On the other hand, continuing price increases for energy and food are reducing the purchasing power of consumers," the ZEW said in a statement.

"Furthermore, loan conditions for companies should worsen as a result of the financial market crisis and the expected interest rate increase by the ECB," it added in reference to the European Central Bank.

The ZEW, which polled 264 analysts and institutional investors for its monthly survey, also said its indicator on the current economic situation in Europe's biggest economy fell 1.0 point to 37.6 points. In the first quarter German gross domestic product (GDP) grew by 1.5 percent or by a real 2.6 percent when adjusted for the number of working days - by euro zone standards a stellar rate.

The ZEW survey adds to evidence that the German economy is entering a period of weaker growth after this strong start to the year, however. German industrial production data for April released on June 6 showed a surprise fall, while numbers for industrial orders published a day earlier revealed a decline for the fifth straight month, and at an accelerated rate.

But although the last time that the ZEW survey reached this low level was when Germany was in a recession, economists are steering clear of the "R-word" this time around.

"(With) generous earnings margins and German companies in a strong competitive position, we do not envisage a recession," Commerzbank economist Matthias Rubisch said in a research note.

Indeed other figures show that Germany's export sector, the backbone of the economy, is doing well despite a stronger euro making its products more expensive compared to those of its competitors from outside the euro zone.

The Bundesbank said earlier this month that Germany's economic performance will be weaker in the coming quarters but it expressed confidence for a pick-up later as global conditions improve and inflation falls. And on Monday two of the country's economic institutes, the DIHK and the IW, hiked their growth forecasts for 2008, to 2.3 percent and 2.5 percent respectively.

But what is new and what has made German investors suddenly more pessimistic is the effect of record oil prices - now close to $140 a barrel - on the interest rate policy of the ECB, economists said. Until recently it was thought that the next move by the bank would be to cut interest rates in the 15-nation euro zone.

But the seemingly inexorable rise in the price of crude and its effect on euro zone inflation - which hit a record 3.7 percent in May - prompted ECB head Jean-Claude Trichet to signal on June 5 a change of tack.

He strongly hinted that the next move would be a tightening, perhaps as early as next month, and many expect that rise might not be a one-off.

"With the economic risks already great, the ECB is running the risk that it will exacerbate the already expected slowdown through a tightening in monetary policy," WestLB economist Jörg Lüschow warned.