The strong first half of the year has been followed by highly erratic data, casting doubts about the real strength of the German economy.
Strong performance in 1H2016
The German economy’s performance in the first half of the year was one of the best performances ever, with an average quarterly growth rate of 0.6%. Private consumption, the construction sector and government consumption were the main growth drivers.
…on the back of low interest rates and influx of refugees
Even though it might be painful for many Germans, the main pillars underpinning the economy currently are two often-criticised factors: the ECB and refugees. The ECB’s ultra-loose monetary policy is not only boosting the construction sector and private spending, but also helping exports to at least partly offset the negative impact from weaker global demand. At the same time, the influx of refugees has led to the strongest government consumption (be aware, not investment) since German reunification.
Industrial production and…
Only industry has trouble shifting into a higher gear. The general trend has been rather horizontal, leaving only very limited room for an increase in investments. With capacity utilisation only close to its historical average, companies seem to use low interest rates and the ECB’s corporate bond purchasing programme as a means to deleverage, rather than as an incentive for more investments. Interestingly, most German companies also do not consider equipment as a limiting factor for production.
…exports, however, remain sluggish
In the same vein, the other former growth engine, exports, is also showing signs of weakness. Bilateral trade data shows that over the summer months, German exports to the US and China have picked up. Particularly the latter suggests that the Chinese economy seems to have left its earlier period of weakness behind. In the Eurozone, exports to France continued their ongoing stagnation. At the same time, German exports to the UK showed the first signs of Brexit weakness.
Looking ahead, domestic demand should cool off somewhat…
Looking ahead, weaker real wage growth and the drop in influx of refugees should weigh on consumption growth, going into 2017. This current growth driver should lose some steam. At the same time, despite some recent positive surprises, there is no reason to get overly excited about industrial production. The best thing about industrial production in the coming months is that it should at least remain relatively stable and should not slow down any further. The process of destocking has come to a (temporary) halt and August new orders brought some relief, showing that order books are still relatively filled.
…while exports should continue to suffer from Brexit uncertainty
Turning to the outlook for trade, the recent nosedive of the Pound Sterling, having lost some 18% against the euro, does not bode well for the German export sector. With exports to the UK still accounting for c.7% of all German exports, even without an actual Brexit, the German export sector should, in our view, already this year, pay a price for the British referendum. Adding to the broader trend of a cooling of global trade, exports should remain subdued, going into 2017.
The government has agreed on the first ‘Christmas presents’…
Against the backdrop of a strong, but stagnating economy, it did not come as a surprise that the German government agreed on a small package of tax relief for households for 2017 and 2018. One year ahead of the national elections, this clearly has the feel of an election gimmick. However, before anyone gets carried away by the idea of large-scale fiscal stimulus in Germany, the announced tax relief should amount to only €6bn spread over two years, less than 0.1% of GDP each year.
…but a significant shift toward more investment still needs to take place…
The government’s move marks an important shift away from a strict focus on austerity and towards slightly more accommodative fiscal policies. Unfortunately, the discussion up to now has, unfortunately, not yet shifted towards incentives for more corporate investments, better access to start-up financing and venture capital and public investments in education and high-technology infrastructure; these being instruments to boost long-term growth, rather than provide short-term stimulus.
…as next year’s national elections are starting to dominate headlines…
With politics and the national elections in September next year taking centre-stage, discussions on the medium-term path of the economy should get more attention. Politicians do have an almost unique opportunity to pave the way for higher sustainable growth in the medium term in good times and not in times of economic crisis.
…showing that populist parties are finally also gaining ground in Germany
Next to the economy, a shift in Germany’s political landscape should keep markets and the electorate busy. The emergence of the AfD, doubts over whether Chancellor Merkel will run for a fourth term in office and possible new government coalitions are among the main themes being discussed in Germany. At the current juncture, a continuation of the present coalition appears to be the most likely outcome of next year’s elections.
In all, the current performance of the German economy remains solid. Although criticising the lack of new reforms and domestic investments is often seen as blasphemy, it is, in our view, justified. The erratic data over the summer months have shown that the economy could easily lose momentum. Simply banking on past successes could be a dangerous strategy. Therefore, the search for the ‘real me’ should continue.