RaboResearch - Economic Research

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Germany: short-sighted fiscal policy could backfire

Economic Update

  • The German economy had a good start of 2016, with growth exceeding expectations in the first quarter
  • We expect growth this year to accelerate compared to 2015 to 1¾% and slow down to 1½% in 2017
  • The rebalancing of the economy towards domestic demand continues, also driven by a buoyant labour market
  • There is scope for increasing German’s potential through investment and structural reform, but this is unlikely in the face of federal elections in 2017

German economy has a promising start of the year

Germany still is one of the fastest growing economies in the eurozone. Growth surprised slightly on the upside by rising to 0.7% quarter-on-quarter in the first quarter of 2016, up from 0.3% in the last quarter of 2015. Growth was driven mostly by domestic demand, signifying the trust of German households to consume, firms’ willingness to invest and a broader rebalancing of the economy away from exports. Households are still benefitting from increases in their real disposable income caused by a buoyant labour market. From a trade point of perspective, Germany’s important manufacturing sector managed to export more. Nevertheless, net export’s contribution is still slightly negative, as imports increased on the back of higher private consumption.

Figure 1: Strong start of 2016
Figure 1: Strong start of 2016Source: Destasis
Table 1: Key figures Germany
Table 1: Key figures Germany Source: NiGEM, Rabobank

Growth remains robust, but faces headwinds

Looking ahead, economic growth is expected to hold up in the remainder of 2016, though at slightly lower rates. Economic sentiment indicators from the European Commission and Germany’s IFO institute rebounded firmly in May and June after the low readings in March and April (Figure 2), but still indicate a slowing down of growth. Manufacturing PMI reached a 2-year high in June. Investment is profiting from high and increasing capacity utilisation rates. Unemployment is at record lows (4.2% in May), improving consumer confidence and employment levels, thereby boosting consumption. Note that these indicators cover periods before the Brexit outcome in the UK. A further positive sign here is that unemployment in East German continues to converge to West German levels (Figure 3). While East German GDP per head is still only about 70% that of in Western Germany, net migration from east to west has recently abated after many years.

Figure 2: Sentiment points to continuing albeit slowing growth in second quarter
Figure 2: Sentiment points to continuing albeit slowing growth in second quarterSource: EC, IFO, Macrobond, Rabobank
Figure 3: East and West German unemployment levels are converging
Figure 3: East and West German unemployment levels are convergingSource: Destasis
Note: National definition of unemployment
Figure 4: Real incomes are still increasing in Germany
Figure 4: Real incomes are still increasing in GermanySource: Destasis, Rabobank

However, uncertainty and slowdowns in Germany’s main export markets (e.g. the United Kingdom after the EU-referendum results) will probably cause export growth to slow down from the first quarters’ high rate. In addition, temporary stimulus from low inflation rates that raise real income (Figure 4), is expected to disappear in the second half the year. That is because inflation rates will then quickly move back to levels of around 1% due to base effects of rising energy prices. This implies a slowdown in consumption growth. We expect real GDP growth to be 1¾% in 2016 and 1½% in 2017 (Table 1), driven mainly by domestic demand. Any effects from the decision of the UK to leave the EU are not yet taken into account in these forecasts.

Germany is obsessed with the black zero at the cost of lower growth

The German federal government achieved a fiscal surplus in 2015 for the second year in a row. 2015 is also the first year that all levels of the German government recorded surpluses, raising the general government’s budget surplus to 0.7% (Figure 5). The government thus has fiscal space to stimulate the economy by investing in outdated (digital) infrastructure and education.

Figure 5: The German government runs fiscal surpluses on all levels
Figure 5: The German government runs fiscal surpluses on all levelsSource: Destasis, Rabobank

It could also be an opportunity to introduce reforms in the labour market (extending the pension age, integrating women and immigrants into the workforce) and the sclerotic services sector. As we have argued before, this could raise Germany’s growth potential by increasing productivity growth and the labour force. The positive spillover effects that fiscal stimulus would have on other eurozone countries is significant as well, as we simulated in June. Unfortunately, there is little reason to assume Germany will change its course after many years of complacency and lack of reforms, especially in the view of upcoming federal elections in October 2017 and a political obsession with ‘the black zero’ (i.e. budget balance). The government will also have to use some of its fiscal buffer to accommodate the recently arrived immigrants.

Daniel van Schoot
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 30381

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