RaboResearch - Economic Research

Germany: better times ahead?


  • We forecast Germany to return to pre-crisis output levels in the first months of 2022
  • The release of pent-up savings will support consumption, but only to some extent
  • Foreign demand is another accelerator, but the export engine misfires due to shortages
  • Germany’s traditional unease with soaring prices will be tested
  • The September election is going to be crucial: does Germany really want to return to the orthodoxies of the 2010s, or has the pandemic been a watershed moment?
  • There is increasing pressure on Germany to position itself in an era of great power competition, as it risks to become trapped between the hammer and the anvil

The only way is up

The second and third wave of the pandemic interrupted the recovery in Germany over the course of the winter. Economic activity already stagnated in late 2020, and gross domestic product declined by 1.8 percent in the first quarter of 2021. This second dip leaves the overall size of the economy 5.2 percent below its early-2019 peak, yet the good news was that the containment measures inflicted much less damage on the economy than during the spring of 2020. The ongoing recovery in global trade provided tailwinds for German industries too, and exports (to non-EU countries) have already recovered most of their earlier losses. The bad news was that the decline in activity was strongly concentrated in services industries and non-essential retail trade.

As such, private consumption was 11 percent lower than in late 2019 and household savings rose sharply. With most pandemic-related restrictions now being lifted –and households able to spend a larger share of their disposable incomes– the German consumer holds the keys to the recovery. Private consumption will rise significantly faster than disposable income in the upcoming quarters, but the extent to which Germans are keen to take out some of their extra EUR 200 billion of ‘pandemic’ savings is crucial. Although there is less labor market uncertainty, which reduces the need for precautionary savings, we don’t want to overhype any drawdown of these savings.

Figure 1: Better times ahead?
Figure 1: Better times ahead?Source: Macrobond, RaboResearch
Figure 2: Consumption should fully recover
Figure 2: Consumption should fully recover Source: Macrobond, RaboResearch

The recovery of private consumption already started in May. Following a rapid continuation of this recovery during the summer, we expect that the pace will then moderate from the fourth quarter onwards. This scenario leads to a seemingly strange forecast: we expect growth of just 1.1 percent this year but 6.5 percent in 2022. In reality, however, most of the normalization takes place this year, and these numbers result from a statistical artefact known as carry-over. Finally, it’s worth noting that this projection assumes that the rollout of the vaccines stays ahead of the spread of the Delta-variant (...or other, new, variants of concern) among the crucial age groups, allowing the government to keep the most stringent non-pharmaceutical interventions at bay.

Figure 3: The decline of the Covid-19 incidence rate masks the underlying rise of Delta
Figure 3: The decline of the Covid-19 incidence rate masks the underlying rise of DeltaSource: Macrobond, Robert Koch Institute
Figure 4: Economic confidence increases sharply
Figure 4: Economic confidence increases sharply Source: Macrobond, Ifo

Sharp recovery

The burden of the pandemic has eased, the restrictions have largely been lifted, and economic activity has restarted. A variety of high-frequency data –e.g. electricity consumption, toll mileage, mobility, air pollution or card payments– broadly indicates that this recovery started in late-April, and gathered traction over the course of May and June. The Bundesbank’s weekly activity index points at an implied quarterly growth rate of 2.9 percent. This bodes well for second and third quarter GDP growth. We forecast quarterly rates of 2.2 percent and 2.7 percent, respectively, and a gradual moderation of growth from the fourth quarter onwards. That said, it can’t be stressed enough that surges of virus variants, starting with Delta, pose the biggest risk to this scenario.

Even as this variant is already getting a foothold in various regions, this doesn’t seem to have had a big effect on confidence yet. Survey data indicate that businesses remain optimistic. In June, the Ifo-index rose to 101.8, mostly driven by improving expectations for the months ahead. The assessment of the current situation also improved, with confidence returning to hospitality and tourism in particular. The PMIs confirm this: the composite PMI rose to 60.4 in June. This is the highest level in 123 months, signalling a sharp and accelerated rise in business activity.

Figure 5: A sharp and accelerated rise in activity
Figure 5: A sharp and accelerated rise in activitySource: Macrobond, Markit
Figure 6: Annual growth rates should normalize
Figure 6: Annual growth rates should normalize  Source: Macrobond, RaboResearch

Germany’s industries should continue to benefit from strong –albeit uneven– foreign demand for its industrial goods. We project the country’s exports to grow 10.1 percent this year and 3.4 percent in 2022. However, this surge in demand for tradable goods was largely unexpected this time last year, and comes on top of structural underinvestment in (global) infrastructure. In a variety of sectors, demand outpaces supply, and this has been a source of widespread disruptions. These expose the bottlenecks in the supply capacity of the global economy.

In the next few quarters, this is projected to lead to a somewhat more subdued recovery of production on top of the sharp increase in price pressures. Looking further ahead, it’s not necessarily bad news, as these bottlenecks also put a spotlight on valuable and profitable investment opportunities. This, and the reorientation of some supply chains as countries try to ‘build back better’, may lead to a prolonged period of demand for Germany’s industrial goods.   

Consequentially, we project German imports to rise too. Its demand for overseas products is mainly driven by three factors, all pointing in an upward direction: the need for intermediate inputs to produce its exports, the need for capital goods for its investments which tend to have a relatively high import content, and the projected recovery of household consumption.

Summing up, we currently project that Germany returns to pre-crisis output levels in the first months of 2022, and see GDP growing 3.4 percent this year, another 4.0 percent in 2022 and then to moderate from 2023 onwards.

Table 1: Economic outlook Germany – selected indicators
Table 1: Economic outlook Germany – selected indicatorsSource: RaboResearch

Asynchronous shocks

Germany’s economy is highly sensitive to the global manufacturing cycle. As such, shocks that reverberate through various international supply chains automatically land on its doorstep. Before the pandemic struck, Germany was already at the epicentre of a manufacturing slowdown. This was the direct consequence of elevated trade tensions and reduced investment appetite. This slowdown was of course exacerbated in the first months of 2020. However, it now faces an upswing of unprecedented proportions.

The global economy recovers from a simultaneous inward shock to aggregate supply and demand. As the reopening takes place in fits and starts, the outward shifts in these curves are not synchronized. In particular in sectors that have been heavily affected by the pandemic, demand quickly exceeds supply. This leads to frictions and hiccups in supply chains. The sudden shortage of semiconductors has been the most prominent example. The lack of availability of key components has forced German car manufacturers to temporarily shut down plants and to run down inventories. While it is not yet possible to isolate the economic effect from these outages from other factors such as Brexit-induced frontloading or last year’s temporary VAT cut, figure 7 shows that there is a wide gap between the orders and the actual production of motor vehicles.

Figure 7: The production of vehicles is falling short of orders due to shortages
Figure 7: The production of vehicles is falling short of orders due to shortagesSource: Macrobond
Figure 8: As inventories run low, production and price expectations increase – temporarily?
Figure 8: As inventories run low, production and price expectations increase – temporarily?Source: Macrobond, European Commission

Industry experts expect these shortages to continue into 2022, as supply of some of these key components is inelastic. These projections are inherently uncertain, but, in our view, experiences like these may induce companies to simplify and shorten their own supply chains.

The relative importance of resilience over efficiency rises in an increasingly fragmented world. But the pandemic has also showed in quite dramatic ways that dislocations in one part of a system affect the whole system. As shocks reverberate through these supply chains, there is a tendency for orders to be more variable than underlying demand signals. This variability increases the further upstream a company is in the supply chain. In particular in long supply chains, where many intermediate goods move back and forth before a final product is delivered to an end-consumer, the participating firms have problems in properly evaluating and forecasting final demand. This eventually leads to pre-cautionary purchases of (intermediate) goods, which may eventually overcompensate for existent shortages and produce gluts. Supply chain specialists and system theorists call this the bull whip effect, which has whipsawing implications for production, inventories, and, eventually, inflation (see figure 8).

Pockets of higher inflation

Germany’s inflation figures in the second half of this year are going to be fodder for headlines about skyrocketing prices. We forecast HICP inflation to average 2.8 percent this year, before falling back to below the ECB’s target in 2022. The peak will be higher still, possibly as high as 4 percent in late 2021. The rise in consumer prices is mainly due to a rise in commodity prices, topped up by base effects resulting from last year’s temporary VAT cut and some pandemic-related changes in the expenditure weights that are used to calculate the inflation indices.

There is a risk that this could influence perceptions after a long period of subdued inflation, but we don’t expect the spectre of inflation to immediately leave its mark on Germany’s wage-setting process. Even as the unemployment rate has only increased slightly, at the peak of the pandemic the employment of six million workers had been sustained through the short-time work scheme. As the labor market recovers, and reliance on these schemes falls back to normal levels, we expect employee working hours to rise first. The level of unemployment should decline too, but this is not necessarily reflected in a similar decline in the unemployment rate if more people feel that it is safe enough to return to the labor force and immigration catches up after the pandemic.

While specific industries may experience labor shortages, due to skill mismatches or Covid-related fears (e.g. with in-person services), which may lead to sectoral wage pressures, the above suggests that the pool of ‘underemployed’ workers should be large enough to avoid widespread shortages. This slack should lead to subdued wage growth for quite some time. Figure 10 shows that wage growth, when looking at collective contracts, is at its lowest level since 2015. Furthermore, there have already been some settlements for 2022 and these have resulted in moderate pay rises.

Figure 9: Germany’s inflation rises due to incidental factors and higher commodity prices
Figure 9: Germany’s inflation rises due to incidental factors and higher commodity pricesSource: Macrobond
Figure 10: Earnings growth has declined substantially since early-2020
Figure 10: Earnings growth has declined substantially since early-2020Source: Macrobond

From a more structural point of view, however, we do see risks of higher inflation over the next decade. In this special, which has a global focus, we set out a framework of what we believe to be the eight most important structural factors currently driving inflation.

Between the hammer and the anvil?

The federal election is scheduled to be held on 26 September. It promises to be a very open race. The CDU/CSU’s ‘pandemic dividend’ has lost some of its value and the incumbency advantage may not be worth all that much. The selection of Armin Laschet as its candidate for the Chancellery failed to garner any excitement. The Green Party initially surged in the polls after choosing Annalena Baerbock as its candidate, but this effect has now largely faded due to allegations about plagiarism and resume inflation. The FDP is making inroads, but their leader Christian Lindner has a history of suddenly walking out coalition negotiations. And then there is also the SPD, the AFD and the Left, all aiming to win their share of the vote. It is going to be a long and particularly uncertain election campaign, which, if anything, leads to increased political fragmentation. The post-election period, and the haggling to broker a coalition, will therefore prove to be very important.

Figure 11: A very competitive field, but the CDU/CSU is still leading the pack
Figure 11: A very competitive field, but the CDU/CSU is still leading the packSource: Politico Poll of Polls
Figure 12: Despite higher public debt, the German government pays less to service this
Figure 12: Despite higher public debt, the German government pays less to service thisSource: Macrobond, EC Ameco

Two issues are particularly relevant from an outside perspective. Firstly, does Germany really want a return to the European monetary and fiscal orthodoxies of the 2010s, as the CDU/CSU’s manifesto seems to suggest? Or has the pandemic been a watershed moment? Secondly, amidst great power competition, is any new coalition government able to articulate a more coherent foreign policy? If not, Germany risks getting trapped between the hammer and the anvil.

No paradigm shift; no return to the 2010s

The initial surge in the Green’s popularity could reflect that there’s a new economic consensus in the making. While most governments in Europe haven’t gone as far as the Biden administration, the perception of public debt isn’t certainly as negative as it was in the 2010s. The failure of the German government (among others!) to engage in debt-financed spending after the crises of 2008 and 2011 has contributed substantially to the chronic lack of private demand, a tilted savings and investment balance, and distortive global and intra-Eurozone trade imbalances.

The financing costs of German debt remains on a firmly downward trajectory (figure 12). Even as government spending has increased markedly due to the pandemic, interest-paying bonds are gradually being replaced by new bonds that don’t pay any interest at all. Recent calculations by the German finance ministry show that, if the German yield curve remains largely unchanged, the government actually starts making money on its debt from 2029 onwards. That is not a healthy situation at all and indicates that Germany should adopt Keynesian policies. This would help to rebalance Europe’s largest economy and could be an unintended benefit of the pandemic.

However, Germany’s fiscal hawks are already crying foul. In mid-June, CDU/CSU leader Laschet saidWhen this crisis is over, when its effects on the global economy are over, German as well as European politics will have to return to the stability policies as defined in the Maastricht Treaty.” Finance minister Scholz, who is the SPD’s candidate for the chancellery, seeks a more balanced approach. In an interview with the Financial Times, he said that “We mustn’t abruptly stop the measures we took to ensure the economic recovery” but also dismissed calls for a structural overhaul of the fiscal rules in Germany and in Europe.

So even as the Greens might push for suspending the German debt brake beyond 2022, this seems unlikely as long as economic growth doesn’t face another setback. A two-thirds majority in the Bundestag is needed to amend the debt brake and the numbers simply won’t be there. The Greens may argue that climate change is an emergency situation that warrants another suspension of the debt brake. In April, Germany’s supreme constitutional court ruled that the current climate protection measures are insufficient to protect future generations. The Greens may not have the leverage to achieve this, but one possible compromise is to use off-budget instruments to finance some highly necessary investments on climate, green technologies and digitalization. Given the high degree of political fragmentation, the risk of delays and watered down ambitions is real.

Another difference between Germany’s political parties is how they view the future of the EU’s Recovery and Resilience Fund. The CDU/CSU and the FDP argue that this instrument is temporary and inherently linked to the pandemic. The Greens view this as the first step towards a more structural feature of the EU’s fiscal policies. The SPD’s leader Scholz once called the RRF Europe’s Hamiltonian moment, but now seems to be walking back on this, realizing that these messages hardly ever lead to domestic electoral successes in Germany.

That said, history shows that the steps that the EU takes on the path of integration are not easily reversed. We note that the Italian prime minister Mario Draghi said earlier in June that “some aspects of the EU joint debt instrument can remain permanent”. French president Macron is also in favour of more permanent solutions for European debt. So, if the CDU/CSU’s Laschet indeed becomes Germany’s Chancellor, these two political heavyweights, may overshadow a relatively inexperienced German leader who will be in charge of a fractured ‘frugal’ pushback.

Mr. Laschet and his team will have to realize this as well, so if Germany really wants to strengthen its (foreign) leadership role in Europe, to pool sovereignty at the EU level, and try to find its way between China-US tensions, the European price that Germany will have to pay is more fiscal integration – not less. To sum up, the federal election wouldn’t necessarily herald a paradigm shift in German politics, but a full return to the old normal of the 2010s seems unlikely either.

Foreign policy becomes more relevant

An election is hardly ever won or lost on foreign policy, but Germany’s industrial commerce and its wealth are strongly reliant on external stability and security. The Trump presidency meant a highly problematic time for German-American relations. Germany now seems wary to respond to Biden’s overtures. But in the paradigm of great power competition, Germany will be required to articulate a more coherent foreign policy than it demonstrated during the sixteen years of Merkel’s tenure. Whilst she did often speak about human rights violations and sought to champion democratic values, in the end she mostly responded to the interests of German industries, which strongly rely on Chinese export markets and on Russian oil and gas supplies.

Germany can’t always have its cake and eat it too, but Laschet nonetheless seems keen to take on the “Merkelcantilist” approach vis-à-vis Russia and China. Yet he may eventually have to respond to the demands of the Greens, who want to see a much tougher line on matters such as human right violations in Xinjiang or Beijing’s curtailment of Hong Kong’s freedoms. Whilst the Greens are not seeking to cut ties with China, they do acknowledge that these demands are not without costs for Germany’s industries.

On Russia, the Greens' election manifesto states that political support for Nord Stream 2 should be withdrawn, even as construction of the gas pipeline is nearly completed. Laschet, instead, supports the pipeline, and the Biden administration has already waived sanctions in order to repair ties with Germany and other European countries in his bid for a stronger alliance to counter China.

We would eventually expect the CDU/CSU will be pressured enough to take a more principled stance on foreign policy matters, to align more closely with the United States, and to continue to build on a long history of German-American relations. As US Secretary of State Antony Blinken saidthe United States has no better partner, no better friend in the world than Germany”. But friendship works both ways. If Germany refuses to acknowledge that, it risks getting trapped between the hammer and the anvil.

Stefan Koopman
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 71 21328

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