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Economic Forecast: Expansion Remains on Track

16.06.2016

The expansion in Germany set to continue. The Forecasting Center of the Kiel Institute for the World Economy expects GDP to grow 1.9 percent this year and 2.1 percent next year. Strong domestic drivers remain the dominant factors behind the high GDP growth rates. Consumption is likely to remain strong, investment is expected to accelerate. The lower number of refugees arriving has hardly any economic impact.

The German economy is set to continue its upward course this year and next, driven largely by domestic activity. The high rate of expansion in the first quarter, with GDP up 0.7 percent, was exaggerated by exceptional factors, such as the mild weather. Accordingly, a somewhat slower pace is expected in the second and third quarters. The basic economic trend is nonetheless upward, with the business outlook having improved again after the slump in February. Domestic order intake has also increased steadily since the start of the year. The small downward revision of the spring forecast of 0.1 per cent is primarily due to less fiscal impetus as a result of the substantial drop in the influx of refugees. “Based on the current almost normal level of capacity utilization, economic output in the forecast period will expand each year by around half a percent more than growth in potential output. Domestic production capacity will thus become increasingly tight“, Stefan Kooths, head of the Kiel Institute Forecasting Center, said.

The expansion is mainly driven by the domestic economy. Consumer spending will continue to expand very strongly, supported by the sharp rise in disposable incomes. Disposable incomes are being boosted both by the sustained strength of the labor market and by relatively high increases in monetary welfare benefits. Investment is increasingly becoming the second pillar of the recovery. Gross fixed asset investment is likely to continue to expand relatively strongly in the forecast period, with only the current quarter seeing a brief interruption of the investment upswing. Since construction spending increased particularly sharply in the first quarter due to favorable weather conditions, there are signs of a correction in the second quarter. Going forward, the extremely accommodative market conditions—in particular the favorable financing terms—should have an effect.

Inflation remains low, labor market situation improve further, exports rise again

General price inflation remains subdued for now, despite rising oil prices, as the somewhat more subdued inflation in the less volatile price categories is likely to be masked by the rally in oil prices, especially in this quarter and the next. On that basis the researchers expect consumer prices to rise by 0.5 percent this year. Next year, they should increase by 1.6 percent and thus somewhat less rapidly than expected in March. The labor market situation will improve further against the backdrop of a buoyant economy and an ongoing employment-friendly trend in wages. The unemployment rate is heading for a new post-reunification low. Consumers will see their purchasing power supported this year by the downward pressure of oil prices on inflation.

Following a weak second half last year, exports picked up strongly in the spring. But even if exports are liable to rise during the forecast period on the back of a gradually recovering global economy, export growth in the current year will significantly lag behind last year's level (3.2 percent compared to 5.4 percent), while imports will again expand relatively strongly as the domestic economy picks up steam (4.8 percent following 5.8 percent).

Public sector budgets remain in surplus, lower number of refugees

Despite sharply rising expenditure, public sector budgets will remain in surplus in 2016. Although the budget surplus is likely to fall significantly overall compared with the previous year, it will nonetheless still be strongly positive at EUR 7.1 billion (0.2 percent of GDP). The influx of refugees has led to a substantial increase in government spending and expenditure on monetary welfare benefits, also there is an appreciable increase in public sector investment, while there will be a sharp rise in pension payments mid-year. Furthermore, public sector employment will expand considerably. The steep rise in expenditure will be partly offset by a significant increase in tax revenue, which accelerated sharply in the first quarter in particular, despite adjustments to income tax rates. The ongoing favorable situation in the job market is also delivering a sustained rise in payroll contributions.

The influx of refugees is having a visible impact on domestic absorption, especially in the current year. It is not, however, shaping economic developments, as other government expenditure and other consumption will raise instead, making the overall effect relatively minor. “It is, in any case, questionable whether one can talk about an economic boost due to the influx of refugees, since this migration is associated with developments, such as armed conflict in the Middle East and political tensions within the European Union, which themselves suppress economic activity, not least through greater uncertainty”, Kooths said

World economy: growth momentum remains weak

Global output (at PPP exchange rates) is expected to grow by 3.1 and 3.5 percent in 2016 and 2017, respectively. While the outlook has marginally improved since March, the underlying growth momentum remains weak. “The expansion in the advanced economies remains tepid. It is getting clearer and clearer that structural rather than cyclical factors are holding back growth which cannot be healed by ever more expansionary monetary policies or fiscal stimulus,” said Kooths. Prospects in many emerging economies have improved with the partial recovery in commodity prices. But also in this group of countries structural impediments to growth stand in the way of a swift recovery.

Comments by Stefan Kooths on the latest forecast: “It is important to avoid economic policy overreactions in the current environment because procyclical fiscal policy is ultimately bad for everyone.”

“The backdrop to the upswing in Germany remains one of exceptional monetary policy conditions. However, the low interest rate environment also has distorting effects on decisions by economic actors in Germany through its impact on other price relationships (not least the foreign ex-change rate). Since the ECB is still failing to achieve its inflation target (as measured by consumer prices), it is gradually making its monetary policy more expansionary. Within the euro area, however, it is primarily the parts that are not struggling with substantial overindebtedness that are susceptible to the credit expansion the ECB is aiming to bring about. As a result, monetary policy is in danger of stimulating the part of the euro area that not only does not need any stimulus of this type, but where such stimulus is counterproductive in terms of stabilization policy. Moreover, economic policy in Germany is increasingly coming under international pressure to abandon its focus on fiscal stability. Given that the German economy is currently at normal levels of capacity utilization, additional fiscal stimulus would be counterproductive in Germany with having very little spill-over effects to the rest of the euro area. In this regard, it is becoming more and more apparent that political tensions within the European Union are increasing and are now considerable. A symptom for these tensions is the referendum on the Brexit scheduled for June 23. The debate on Brexit has led to a spike in political uncertainty, which is already dampening economic activity, mainly in the United Kingdom. If voters choose to leave the European Union this uncertainty would increase and could considerably dampen economic activity in the European Union, including Germany. However, the negative economic effects for the United Kingdom are expected to be much larger.”

The complete Business Cycle Forecasts can be found here.

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