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Business Cycle Forecast of the Kiel Institute for the World Economy: German economy on the road to overheating

12.03.2015

German economy is regaining momentum driven by private consumption – German GDP is expected to increase by 1.8 percent (2015) and 2.0 percent (2016) – Unemployment, already at record-low numbers since reunification, to decline further – Only moderate fiscal surpluses despite a very favorable macroeconomic environment – Economy dives into moderate overutilization – overheating on the horizon – Euro area shows moderate recovery, global economy expanding slightly stronger

German GDP is expected to increase by 1.8 percent this year and 2.0 percent next year. In 2015, economic activity is mainly driven by consumer spending (+ 2.7 percent, a two-decade record high number) and housing constructions (+ 3.8 percent), complemented by corporate investment spending as the second growth pillar next year (+ 6.6 percent in 2016, after 2.6 percent this year).

In 2015, consumer spending is boosted by strong wage earnings, expanded social transfer programs, and purchasing power gains from low energy prices, in particular in the first half of the year. Foreign trade flows will gain momentum, but net exports remain neutral in terms of stimulus effects during the forecasting period leaving the current account surplus at a level of about 250 billion Euro in both years (after 219 billion Euro last year).

The economy is operating at normal capacity utilization rates this year (closed output gap), but will dive into moderate overutilization territory next year. Given the weak potential growth rate of 1 ¼ percent the German economy is prone to over­heating as the ultra-low interest rates are likely to strongly stimulate the economy in the upcoming years. In line with increasing production numbers, the labor market will continue to create more jobs (+ 340 000 in each year). Unemployment rates, already at record-low numbers since reunification and as low as nowhere else in the European Union (according to the ILO concept), will come down even more: 5.0 percent (2014), 4.7 percent (2015), 4.4 percent (2016).

Consumer price inflation remains subdued in 2015 due to the recent oil price slump. However, domestic upward price pressure remains unaffected. The GDP-deflator is expected to increase by 2.1 percent in both years after 1.7 percent in 2014. With base effects fading out, consumer prices will start to increase during the current and next year. Despite the high momentum in GDP growth public finances will not show higher fiscal surpluses. The fiscal balance remains very moderate in both years (0.3 percent in relation to GDP) not showing ambitious consolidation endeavors despite a very favorable macroeconomic environment.

Euro area shows moderate recovery

Euro area GDP growth accelerated slightly in the fourth quarter of 2014. Our assessment of the business cycle suggests that the recovery continues, but the speed of the recovery will only be moderate. Overall, we expect a GDP growth of 1.3 percent in 2015. In 2016, the recovery is forecast to gain some momentum so that the increase in output is 1.7 percent. We expect GDP growth to be more and more driven by domestic factors. Private consumption expenditures will benefit from low energy prices and the stabilization of labor market conditions as well as a slow pick-up of wages. After an average inflation rate of 0.4 percent in 2014, we project that the overall price level stagnates in 2015. In the year 2016, prices will increase by 1.1 percent. The rise in employment has accelerated over the past year. This recovery will continue during the forecasting period. We expect the unemployment rate to drop to 11.1 percent on average in 2015. In 2016, unemployment will decline further to 10.5 percent. In 2014, the consolidation of public finances came to an end. The improvement of the budget balance in 2015 and 2016 will be solely due to the improved business cycle conditions and lower interest payments on outstanding debt. The deficit is projected to shrink from 2.5 percent in 2014 to 2.3 percent in 2015 and to 2.1 percent in 2016.

Global economy expanding slightly stronger

World economic growth is expected to accelerate from 3.5 percent last year to 3.7 and 4.0 percent in 2015 and 2016, respectively, on a PPP-weighted basis. Economic momentum is forecast to pick up mainly in the advanced economies where, with deleveraging in the private sector having gone a long way in a number of important economies, monetary stimulus increasingly impacts on demand and lower oil prices have raised purchasing power. While emerging economies stand to benefit from stronger demand, economic growth in this group of countries will remain muted. China continues to shift towards a lower growth trajectory, and structural problems in combination with substantially lower commodity prices weigh on the outlook in Latin America and, especially, Russia. Despite significant changes in the economic environment, including the steep fall in oil prices and substantial changes in the exchange rates of the major currencies, since summer 2014 the world economy has more or less evolved as expected.

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