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Blog Carsten Brzeski

German Economic Outlook 2017: Politics are entering center stage

A gradual slowdown since the start of the year ...
The gradual slowdown of the economy continued in the third quarter. Since the start of the year, quarterly GDP growth has come down from 0.7% QoQ in Q1 to 0.4% QoQ in 2Q and 0.2% QoQ in 3Q. However, despite this obvious downward trend, overall performance since the 2008-09 crisis has been impressive.

…is no reason, as yet, to become overly concerned
The economy grew during 27 of the past 30 quarters, by on average 0.5% QoQ each quarter. Moreover, private consumption has shown its best performance since the initial reunification boom. On the back of the strong labour market, low inflation, low interest rates and higher wages, private consumption is currently experiencing the strongest and longest stretch of consecutive growth since 1992. Even though third quarter performance was the result of a Brexit-driven rollercoaster ride, the big picture is still one about which to be proud.

The growth drivers of 2016 will be the growth drivers of 2017…
Unfortunately, as so many good things, the current positive growth cycle is also coming to an end. Gradually, not abruptly. Looking into 2017, the upside for the German economy is that the main growth drivers of 2016 should still be the main growth drivers of 2017, only weaker. Construction, the best-performing sector currently, should continue to benefit from low interest rates and excess demand for housing in urban areas. Consumption should continue to thrive on the back of the strong labour market, higher real wages and low interest rates. Finally, government consumption should remain high as the influx of refugees requires continued expenditure. However, these three drivers are unlikely to gain momentum as interest rates are unlikely to drop further, inflation is gradually moving upwards and the labour market has reached its natural rate of unemployment.

 

Fig 1 Unemployment still dropping…

Source: Thomson Reuters

Fig 2 …keeping consumption strong

Source: Thomson Reuters

 

…but external risks have increased
In addition, former growth engines currently do not look as if they could take up the baton again. Industrial production and exports have been almost stagnant for more than a year. With several new external risks looming, it is hard to see how this trend can be reversed quickly. A move towards more protectionism by Germany’s single most important trading partner (the US), an entire series of political risk events in the Eurozone and Brexit add to the external downside risks for the German economy.

Politics to dominate headlines in 2017…
The big European theme of 2017 will affect Germany indirectly as well as directly. The national elections after the summer should be the final step of an entire series of political risk events in Europe in 2017. While the threat of populism currently looks limited, a surprise outcome should not be excluded. In our view, a fourth term in office for Angela Merkel is anything but certain due to two main reasons: election arithmetic and Merkel’s style.

…with Merkel running for a fourth term in office…
Regarding election arithmetic, next year’s elections could see six parties entering the national parliament. This would be a primer for German politics. Consequently, forming a coalition will be far more difficult than in a three or four party parliament. Currently, the grand coalition of CDU and SPD would be the only two-party combination which would ensure more than 50% of all votes. Other options such as CDU, SPD, Greens or CDU, Greens and FDP or SPD, Greens and FDP or SPD, or Greens and Left should not be ruled out next year. This would require an unprecedented willingness to compromise from all parties.

…which is less likely than currently expected by international observers…
Finding a government coalition could become even more complicated if Angela Merkel were to lose more of her radiance. Interestingly, Merkel running for a fourth term brought some relief to financial markets and international observers. Particularly after the US elections, many observers had called Angela Merkel possibly the last leader of the free world. As the longest serving leader at the helm of a European national government, Merkel stands for continuity and stability. At least at the European and international level. At the national level, however, Merkel’s announcement to run again met less enthusiasm, and some mixed feelings. While the German economy is still surfing on the waves of a positive business cycle, the list of unfinished works and new economic challenges has become longer. Just think of the lack of new structural reforms, subdued investments in both traditional and modern infrastructure, or the impact from low growth and low interest rates on Germany’s pension system.

Fig 3 German economy in a nutshell (%YoY)

 

2015

2016F

2017F

2018F

GDP

1.5

1.8

1.5

1.5

Private consumption

1.9

1.7

1.0

1.0

Investment

1.1

1.9

0.9

2.5

Government consumption

2.8

4.3

3.6

1.4

Net trade contribution

0.1

-0.2

0.0

0.1

 

 

 

 

 

Headline CPI (%)

0.1

0.4

1.6

1.7

 

 

 

 

 

Unemployment rate (%)

4.3

4.1

4.2

4.3

Budget balance as a % of GDP

0.5

0.6

0.2

0.0

Government debt as a % of GDP

71.1

69.0

67.1

64.9

Source: Thomson Reuters, all forecasts ING estimates, unemployment rates according to national definition

…leaving room for an exciting election campaign…
It is impossible to predict the outcome of next year’s elections ten months in advance. Too many things could still happen. Our base-case scenario would be that Merkel would be strong enough to head the next government, either in a coalition with the SPD or together with the Greens and the FDP. Against the background of a strong economy, voters could be inclined to vote for continuity and stability. However, Merkel’s political style of being cautious, diplomatic and not very outspoken (once a success formula) has been criticized more frequently in recent months. A sudden slide in public support and a change in government cannot entirely be excluded.

…and some real surprises
While at first glance everything seems to be set for Merkel 4.0, the German elections could offer some real surprises.