Most forecasters expect German gross domestic product (GDP) growth to be around 2-2.5% this year, lower than the 2.9% growth achieved last year. Some think it could even fall into recession in the second half of 2022, if the knock-on effects of the war in Ukraine worsen.
Dr Gaurav Ganguly, head of Europe, the Middle East and Africa economic research at Moody’s Analytics, is downbeat about the immediate future for the German economy. “While we still expect the recent relaxation in Covid-19-related restrictions to support economic activity, especially in contact-related service industries, the growth outlook for Germany has darkened considerably in recent months,” he says.
“The Russian invasion of Ukraine and new Covid-19 related lockdowns in China have resulted in higher prices, especially those of energy and a number of agricultural and industrial commodities, and they have further impacted already scrambled supply chains,” Mr Ganguly continues. “Inflation has increased significantly in recent months and the German consumer has become considerably downbeat as a result. High prices and supply chain disruptions have also led to soft production and a deteriorating outlook for corporates.
“As a result, we have reduced our growth forecast for this year and the next by close to 1% since February, and we currently expect the German economy to grow by 2% in 2022 and 2.6% in 2023. There are significant risks to this forecast and the probability that Germany could slip into recession over the course of the next few quarters is close to 50%.”
The war in Ukraine has created humanitarian, political and economic crises in Europe which Germany feels keenly, but it is particularly vulnerable given its acute dependence on Russia for its energy needs. Mr Ganguly says the country sources 35% of its oil and almost 55% of its gas from Russia, and a sudden stop in supplies would be extremely damaging.
“Germany is working hard to wean itself off Russian oil and gas by expediting the construction of new floating liquefied natural gas container terminals and regasification units, and by attempting to put in place a long-term gas supply agreement with Qatar,” he says. “As part of a wider EU plan, it will also have to implement more ambitious energy efficiency and renewable energy targets in order to reduce its overall reliance on fossil fuels.”
German inflation has averaged only 1.4% over the past two decades, but spiked to 7.4% in April. It is driven largely by the increase in energy prices, which rose almost 37% year-on-year. Petrol prices alone have increased by about 20% since the start of February.
“The rise in prices has outstripped wage growth thus far and, as a result, household income is falling behind,” says Mr Ganguly. “Inflation is not just a German problem; it is a problem for the entire eurozone. The European Central Bank (ECB), after several months of watching and waiting, now looks increasingly determined to raise interest rates in July for the first time in over 10 years.
He continues: “The speed at which the ECB tightens monetary policy is of immense concern. If it moves too slowly, inflation could become a very persistent problem for Germany and other countries; but if it moves too aggressively, there is a significant risk that households and firms will be squeezed, sending Germany and the rest of the eurozone into recession.”
The spectre of recession
Claus Vistesen, chief eurozone economist of Pantheon Macroeconomics, says he cannot be certain about the near-term outlook following the release of the official first quarter statistics on the economy, which included “wild volatility in inventories (up) and net exports (down)”. Reversion to the mean in these components usually takes place quickly on a quarter-to-quarter basis, “so anything can happen in the next few quarters”, he says.
That said, the broad themes are clear enough. “On the positive side, Germany’s economy will be supported in the second quarter by pent-up demand in services, lifting consumer spending, as Covid-sensitive sectors stretch their legs after having been constrained by restrictions in the fourth quarter last year and in the first quarter this year,” says Mr Vistesen.
“On the negative side, high inflation is now a significant constraint on consumers’ purchasing power and some firms’ profits. The threat from rapidly rising inflation sapping growth in wages and profits was a threat before the war in Ukraine, and has now been made worse by Mr Putin’s invasion. We think the economy will remain resilient in the second quarter, primarily thanks to strength in services, but by the second half of the year we suspect domestic demand, especially spending, will be overwhelmed by rising inflation and we think a recession looms in the second half of the year.”
He therefore forecasts that growth in Germany will be 1.4% in 2022 – including a technical recession in the second half of the year – and 1.7% in 2023. He believes the federal government will offer some support to the economy and, depending on what that is, he is ready to lift his forecasts. But it is always difficult for governments to prevent inflation from pulling down growth, he adds.
“Our view that the German economy will fall into recession is primarily due to the severity of the inflation shock, supported by the sharp fall in inflation-adjusted M1 growth and the Ifo Institute for Economic Research’s recessionary expectations,” says Mr Vistesen. “Granted, other surveys have been more resilient, mainly the purchasing managers’ indices, and if they stay at their current levels over the summer, we’d be forced to revisit our forecasts.”
Mr Vistesen thinks there will be four interest rate hikes this year from the ECB – 25 basis points (bps) in July, 50bps in September, 25bps in October and 25bps in December, “and this despite the fact that it will almost certainly downgrade its GDP growth forecasts”.
In contrast to Mr Vistesen, the Ifo Institute for Economic Research at the University of Munich, widely known for its monthly Ifo Business Climate Index, believes a recession is unlikely. “Sentiment in the German economy has brightened,” it said on the publication of its latest index, which rose to 93.0 points in May, after reaching 91.9 points in April.
There are approximately 9000 companies in the survey and they “were above all much more satisfied with their current business”, said the Ifo. “The German economy has proven itself resilient in the face of inflation concerns, material bottlenecks and the war in Ukraine. There are currently no observable signs of a recession.”
Still highly rated
Despite problems in the economy, in May Fitch Ratings affirmed the country’s long-term foreign-currency issuer default rating at AAA with a stable outlook. The agency said the rating reflects “Germany’s diversified, high value-added economy, strong institutions and record of sound public finances that have enabled a robust policy response to the pandemic shock.”
It noted that the German economy grew by 2.9% in 2021, a weaker performance than it expected at the time of the last rating review in October 2021. Its latest forecast is a gradual slowdown to 2.5% GDP growth in 2022 and 2.1% in 2023, in line with the overall eurozone trend.
“However, there are significant downside risks related to a more severe economic fallout of the war in Ukraine and the sanctions against Russia, through for example a cut to gas supplies or further supply chain disruptions, higher energy prices or shortages in raw materials. Inflation, annual Harmonised Index of Consumer Prices (HICP), increased to 7.6% in March 2022, driven primarily by the surge in energy prices. Core inflation was 3.3% in March, higher than both the ECB’s 2% HICP target and its pre-pandemic average of 1.4% over 2015-2019,” according to Fitch.
Banks prove resilient
In light of the challenges facing the economy, Professor Claudia Buch, vice-president of Deutsche Bundesbank, responsible for financial stability, statistics and internal audit, highlights the need for a resilient, stable and well-functioning financial system. “The current geopolitical and macroeconomic situation has clearly changed the landscape in which financial institutions are operating, but so far we have not seen any severe disruptions in the financial system,” she says.
The reforms implemented over the past decade are now paying off, says Ms Buch, and have helped increase the resilience of the financial system. “The higher levels of capitalisation evident in banks benefits society because they are in a better position to absorb losses. This mitigates the risk of adverse feedback effects between the financial system and the real economy,” she adds.
However, Ms Buch sees two major risks to financial stability. “First, future macroeconomic risks and the associated losses might be underestimated. The next recession will be different – we are likely to see more corporate insolvencies and less public policy support to absorb losses. Second, structural change is gaining pace due to geopolitical risks, digitalisation and the climate transition.”
She continues: “We need to prepare the financial sector for this period of heightened uncertainty. At the Bundesbank, we are therefore strongly committed to our financial stability mandate.”
