When bad news seems good: German GDP forces a “rethink” of the country’s economic model

0

German economic data was in the spotlight earlier today with Q2 GDP advancing by 0.1%, narrowly avoiding stagnation, and coming in just barely above estimates of 0%. The economy had ticked higher by 0.8% during Q1.

Economic growth has slowed significantly amid the ongoing tension with Russia and inconsistent gas flows driving prices higher and fuelling market uncertainty.

With the government reeling under the pressure to hastily shift away from Russian gas, consumer demand was weak as retail sales dipped amid runaway inflation.  

Despite darkening clouds, Q2 GDP increased by 1.7%, which was above market expectations of 1.4% but much lower than Q1’s annual growth of 3.6%.

Second quarter growth was primarily driven by higher government expenditure.

Source: TradingEconomics.com

Katherine Neiss, Chief European Economist at PGIM Investments notes that Germany’s long-term difficulties stem from a chronic under-investment, contrary to many other European countries. She describes Germany’s commitment to the politics of austerity since the 2008 crisis as “death by a thousand cuts”.

This has chipped away at the resilience of what was once Europe’s economic marvel. The Russia-Ukraine war and consequent energy shortages are just the latest symptoms of this underlying weakness that continues to fester.

Business confidence

Germany’s Ifo Business Climate Index fell to its lowest level in 2 years, registering a 0.2-point drop since July to come to rest at 88.5. Private companies are facing both a supply and demand crunch, amid falling household purchasing power.

Culturally, Germany has long been considered to be highly averse to inflation.

Despite some union negotiations and salary improvements, real wages are reported to have declined 3.6%, dampening the prospect of a rebound in private sector appetite. This is compounded by ageing demographics in the region.

However, markets were pleasantly surprised to see that this reading was considerably higher than expectations of 86.8. The DAX which had declined to a low of 13,210.99 at 11:50 am CEDT trended higher to 13,237.17 by 12:20 pm CEDT.

Both the Current Assessment Index and the Business Expectations Index fell by 0.2 and 0.1 points to 97.5 and 80.3, respectively.

Earlier in the week, the S&P Global Flash Germany PMI Composite Index declined deeper below 50, and settled at 47.6, well into contraction territory.

Outlook

Ifo President Clemens Fuest didn’t mince his words saying the atmosphere is “clearly pessimistic.”

Given the vulnerability of the economy, Neiss forecasts that in an extreme scenario of Russian gas flows completely drying up, the economic impact “could approach a staggering 15 per cent of German GDP.“   

Melanie Debono at Pantheon Macroeconomics expects a material decline in economic activity and estimates that Q3 GDP will contract by 0.5% and Q4 by a further 0.4%.

The pessimism is confirmed by the downward trend in Germany’s MAUT truck toll index, a proxy of economic activity. It registered a seasonally adjusted high of 147.4 during the week running up to the new year but fell to 117.4 on the 20th of August 2022.

Ifo economist Timo Wollmershaeuser concurs with Debono and expects that GDP will fall by 0.5% in the quarter leading to September.

The country’s monetary authority, the Bundesbank forecasts Q3 growth to be flat while conceding that the risk of contraction in Q4 has increased “considerably.”

Way forward

Instead of tighter fiscal and monetary policy, Neiss calls for “bold action and a rethink of the country’s economic model.”

This would primarily involve the following:

Germany taking a leadership role in promoting trade ties within the EU, the largest trading bloc in the world. This is especially pertinent as several partners, especially China, are beginning to look inward with rising protectionist measures.Heavily invest in public infrastructure, especially in energy to manage potential supply shocks. In her view, policymakers must be open to nuclear power and fossil fuels being part of the mix, at least for the foreseeable future. Without these components, Germany will not be able to develop a robust energy system to drive future growth.

Although such measures will undoubtedly increase public indebtedness, by investing in growth-oriented projects, Germany could still move towards sustainably building long-term assets. According to Neiss, the alternative is “a permanent loss of GDP.”

The post When bad news seems good: German GDP forces a “rethink” of the country’s economic model appeared first on Invezz.