Germany: Recession in Sight

The German economy will not escape the effects of the crises in many parts of the world. Both, data for demand and production and important survey indicators point clearly downward. While GDP in Germany might lose less momentum than production in other large countries, where the economic exaggerations were more pronounced in the past years, a slight downturn of production in the coming months is nevertheless probable. We revise our forecast for GDP growth in the current year from 2.1 per cent to 1.9 per cent. For the year 2009 we now only expect an increase by 0.2 per cent (June: 1.0 per cent).

A number of indicators have declined significantly in recent months. The business climate index has fallen substantially, with a particular sharp drop in business expectations. Orders to manufacturing have been declining since the beginning of the year, especially orders from EMU countries. Manufacturing firms have been driving down production since spring. And retails sales also show a downward trend. Fall all these reasons, we expect GDP not to grow in the rest of the year.

The housing crisis which is now affecting more countries – and some countries more severely – than previously forecast, will continue to dampen economic activity in Germany. The housing market in Germany is not affected – the exaggerations occurred more than ten years ago and the correction that followed is finished. In fact, these corrections are one reason why German households enter the current economic slowdown with less debt than during the slowdown of 2001–03 and than households in many other countries in the euro area. Moreover, indebtedness of non-financial firms is also lower than in many other euro area countries, thanks to the high growth of profits in recent years. Nevertheless, the German economy will be affected by the fact that a number of its main trading partners now have severe economic problems in their housing markets. The countries will most probably not escape a recession or a prolonged downturn.

A further strain to the outlook is the continuing financial market crisis. A number of German banks have reported losses originating in the US mortgage market and therefore face the slowdown with reduced capital. Losses will now rise because of the economic slowdown and this will weaken bank capital further as will the flat or even inverse term structure of interest rates. All this means that banks will become increasingly reluctant to lend and this will raise costs of finance to households and non-financial firms. However, given that indebtedness is less than in many other countries and given that two thirds of the German banking sector are represented by savings banks and cooperative banks, which have not incurred losses on the US mortgage market, the situation may be less severe in Germany than in other countries.

Against this background, we expect real GDP to stagnate in the second half of this year. Exports will even fall, as will domestic demand. All in all real GDP will grow by 1.9 per cent in 2008. The situation on the labor market will continue to improve slightly. On average, the number of unemployed will fall significantly in 2008, by 500,000 persons, to 3.25 millions. With falling raw material prices, inflation will lose momentum; the inflation rate will be 2.9 per cent for 2008.

Next year, world economic growth will pick up slightly, so export growth will again be positive although still very moderate. Investment will grow somewhat, given that monetary policy is loosened and interest rates fall. Private consumer expenditures will increase only slightly as real disposable income growth is dampened by falling employment. With only 0.2 per cent, GDP growth will fall significantly below potential output growth in 2009. Unemployment will increase to 3.5 millions; the inflation rate will remain relatively high, at 2.4 per cent, not least because wage growth accelerates.

Key Economic Data for Germany, 2006–2009

 
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