German economy under pressure

For a long time, Germany was considered Europe’s engine of growth. But now its economy is feeling the strain of a significant slide in exports. The picture does look better on the domestic front, however. Several key sentiment indicators are raising expectations of an economic upswing in the second half of the year.

The German economic engine has been spluttering in recent months. GDP fell in the third quarter of 2018 and increased by a mere 0.02 per cent in the fourth quarter. Germany thus only just avoided a technical recession. The prevailing economic trends are atypical in more than one way. While the industrial sector is in a slump, the service sector seems unusually stable. This is particularly surprising given the fact that domestic demand in Germany has historically tended to be weaker than the export sector. Now it is domestic consumers who are shoring up the economy.

In January 2019, the purchasing managers’ index for the German industrial sector fell below the 50-point mark – which separates expansion from contraction – for the first time since November 2014. The situation failed to improve in the months that followed – quite the opposite, in fact. In March, following eight successive periods of decline, the barometer dropped to 44.7 points, its lowest level for six-and-a-half years. Its subcomponent for new industrial orders from home and abroad has also fallen to levels well below 50 points in recent months. March’s Economic Sentiment Indicator (ESI) provided further evidence of an ongoing slump in manufacturing. And given that there are no signs yet of a rally in global growth, the situation for German foreign trade is likely to improve only modestly in the near term.

Industry weak – services stable

German purchasing managers' indices
German purchasing managers' indices
Source: Destatis; as at 2 April 2019.

Economic slowdown and protectionism weighing on exports

The recent data highlights what we already know – that the German economy is heavily reliant on exports. When global economic growth is strong and synchronised, there is a lot of demand from abroad for Germany’s products. But because the world economy began to cool significantly last year, appetite for German imports has waned almost everywhere. Germany’s biggest trading partners are – alongside the US and China – its European neighbours, who are themselves having to contend with a weakening economy.

The rise in protectionism is also having an impact. The customs tariffs and import restrictions threatened by US President Donald Trump are at the centre of the prolonged trade dispute between the US and China. Germany is feeling the impact too as it does a huge amount of trade with both countries. What’s more, China is also battling an economic slowdown. Last year, the world’s second-biggest economy grew at the weakest rate since 1990. Beijing is seeking to reverse this trend by cutting taxes to reduce the burden on companies and consumers, by increasing spending on infrastructure and by making it easier for small and medium-sized businesses to borrow. The consequences of China’s growing pains extend well beyond the borders of the country itself.

German exports

Share of GDP in 2018
Share of GDP in 2018
Source: Destatis; as at 2 April 2019.

Economic optimism returns

Despite all this, there is no reason to be overly pessimistic about Germany. The picture does look much better on the domestic front, after all. The situation in the German labour market, for example, has remained stable in recent months in spite of the weakening economy. According to market research company GfK, German households will see their disposable income rise by nearly 3.5 per cent both this year and next. Because of this, GfK is also predicting a 1.5 per cent rise in consumer spending for 2019 as a whole. This is despite the slightly subdued trend in March, when consumers’ income expectations and willingness to make large purchases contracted due to the uncertainty surrounding Brexit and the trade dispute. These factors were reflected in the GfK consumer climate index, which fell by 0.3 points to 10.4 points. But because German consumers are now more optimistic about the economy again, their spending levels remain exceptionally strong overall.

Sentiment has also improved among companies of late. The Ifo business climate index surprised the markets in March with a rise from 98.7 to 99.6 points – the first upswing following six declines in succession. The companies surveyed were more optimistic about both the current situation and the future outlook than in the previous months. The trend in business appears to be mirroring the rest of the leading indicators: whereas the Ifo index for industry fell to its lowest level for around seven years, sentiment in the service sector and in retail improved significantly.

Weaker growth, but no recession

Union Investment’s own leading indicators are also pointing to a shift in sentiment. The barometers for the US (ULI), the eurozone (ELI) and China (CLI) have all reversed and started to climb again, . and this trend is likely to continue for the time being. China’s extensive economic stimulus package and the major central banks’ looser monetary policy will provide support. However, the economists at Union Investment are still predicting that German economic growth in 2019, at 0.7 per cent, will be much lower than in the previous year, not least because of the faltering industrial sector. At the same time, the current strength of the service sector is proving to be a stabilising factor for the German economy. The experts therefore anticipate a much more stable growth rate of 1.3 per cent for 2020.

 

Unless otherwise noted, all Information and illustrations are as at 25 March 2019.