Germany's first sentiment indicators since the escalation of the Ukraine-Russia crisis are pretty unambiguous: uncertainty is starting to hit the economic outlook and could well impact second-quarter growth, even as mild weather has helped the Eurozone's largest economy power ahead in the first three months of the year.
Ifo's March business sentiment index Tuesday, like ZEW's index of investor sentiment before it, painted a picture of solid and growing confidence in the current economic situation, reflecting a mild winter that has driven up construction and industrial production. But concerns about Crimea have lowered the economic outlook for the coming months, dragging the overall sentiment indices down with it.
The sentiment declines for businesses in particular were not especially significant, while the current conditions gains show there has yet to be any real material impact on output. Ifo slipped 0.6 points to 110.7, with current conditions up 0.8 points to 115.2. ZEW's main indicator fell more sharply, down 9.1 points to 46.6, though here too the view of current conditions improved, up 1.3 points to 51.3.
Both groups however stressed the already-visible negative impact of the crisis, which has seen Russia annex the Crimean peninsula and gather troops along Ukraine's eastern border, prompting targeted sanctions by the West on some of Russia's key decision-makers.
Ifo head Hans-Werner Sinn said the events in Crimea, as well as fears of a slowdown in emerging markets, are having a clear effect on German business confidence. ZEW economist Michael Schroeder last week warned that larger companies that do business with Russia in particular are facing "enormous uncertainty."
Bundesbank President Jens Weidmann has said the economic impact of the crisis in the Ukraine alone is limited, but a wider disruption of relations with Russia are "a more important factor for our risk analysis than the relationship with the Ukraine."
Some 3% of Germany's total exports flow into Russia, while Russian debt owed to German banks amounts to about E24 billion, Weidmann said. The Chamber of Trade and Industry (DIHK) says about 400,000 jobs are dependent on trade with Russia, with some 6,200 German firms active there.
Weidmann said key will be whether economic sanctions are imposed by western nations, a move that G7 and European Union leaders have consistently said they will not rule out if the crisis with the Ukraine escalates. This means that any Russian incursion beyond Crimea into eastern Ukraine will very likely trigger a heavier western response.
German economists and business associations have repeatedly warned over the last few weeks that an escalation of the geopolitical crisis with Russia that leads to economic sanctions is not a one-way street - it will impact growth in the fragile Eurozone and in its largest economy.
"Drastic economic sanctions are currently unnecessary and wrong," said Hannes Hesse, head of the machinery association VDMA in a statement Tuesday. "The Russian economy is already suffering from the tense political situation."
While the decision to impose sanctions will be a political one, concern over the economic fallout no doubt explains some of German Chancellor Angela Merkel's hesitancy to escalate the crisis too quickly. On Monday she reiterated that the EU remains in "phase 2" of the crisis response to Russia's actions, with phase 3 - economic sanctions - being "actively prepared" in the case of a further escalation by Russia.
The German Finance Ministry also labelled the Ukraine crisis a "downside risk" to growth in its monthly report Tuesday, though both the ministry and the Bundesbank's Weidmann caution that any projections of how a further escalation will hit the economy are highly speculative.
The sentiment indicators suggest there has already been some effect, through the predictable route of heightening uncertainty, which could in turn delay new orders and hiring decisions at firms if the situation drags on many more months.
Markit's purchasing managers survey on Monday indicated that new business for German manufacturers fell to a five-month low, helping drive the overall flash manufacturing indicator for March down to 53.8, a four-month low but still well in positive territory.
Clearly this uncertainty has not had much impact on the first quarter. The overall PMI results for the first three months of the year point to GDP growth of 0.7%, according to Markit economist Oliver Kolodseike, which would be sharply up from 0.4% in 4Q 2013. Other analysts are forecasting growth as high as 1%, as a mild winter has likely helped push output in 1Q well above Germany's growth potential.
Germany's Bundesbank in its monthly report Monday said it expects a "strong" weather-related uptick in 1Q GDP that will likely lead to a significant drop in the second-quarter growth pace. While still a ways off, DZ Bank said we can expect to see a 2Q GDP figure below 0.5%.
"Should it come to economic sanctions against Russia, the negative effects for the economy here at home will be unavoidable," DZ Bank Chief Economist Michael Holstein said in a client note Tuesday.