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Economic forecast: German economy approaches boom phase

Economic momentum in Germany is accelerating, along with the danger of substantial overheating, with corresponding potential for a setback. Capacity utilisation is already appreciably exceeding the normal level, and the increase in Germany's economic output is increasingly heading upwards, away from a sustainable growth path. This topic is dealt with the Economic Report published today by the Kiel Institute for the World Economy (IfW) until 2019, in which the researchers respond to upward revisions to the official statistics. On the whole, however, they have maintained their previous economic outlook.

They have raised their forecast for the Gross Domestic Product (GDP) growth rate by 0.3 percentage points to 2 per cent for the year 2017 and by 0.2 percentage points to 2.2 per cent for 2018. “Adjusted for working days, this is likely to represent the high plateau of the speed of expansion in an unusually long, protracted upturn culminating in a boom phase in the forecast period,” said Stefan Kooths, Head of the IfW Forecasting Centre.

“A boom economy feels good but is detrimental in terms of its macroeconomic impact. Exaggerations during the boom phase delude private market participants into making misguided decisions, mostly flanked by all too reckless economic policy. Business models that only work during a boom need to be scrapped again sooner or later. The situation is similar as regards state benefits lacking in sustainable funding. On the whole, therefore, scarce resources are misallocated and structural change is impeded.”

For 2019, the economic researchers anticipate GDP growth of 2.1 per cent. “The overall picture of the German economy is pretty much the same as we had expected at end-2016, when the trend towards normal capacity utilisation being exceeded first made itself felt,” said Kooths. “Slightly weaker consumer spending momentum is overcompensated by more buoyant external trade and investments picking up sharply again.”

Indications are that corporate investments in the forecast period are likely to accelerate due to highly favourable revenue and earnings prospects and are now also expected to exceed equipment investments of pre-crisis levels, especially since the strain factors resulting from the uncertain international environment evidently are gradually growing weaker. Moreover, construction investments will continue to rise at high rates due to the highly stimulating general framework, including the extremely favourable financing conditions.

Low financial policy leeway

The ongoing favourable situation prevailing on the labour market will make the unemployment rate decline from a current level of 5.7 per cent to about 5 per cent towards the end of 2019. The volume of work performed is then likely to reach an all-time high for unified Germany. Effective hourly wages continue to rise at above-average rates, enabling employees to benefit from sizeable gains in real wages. Against this backdrop, private consumer spending will probably increase by 1.75 per cent per annum in the coming years.

The phase of very low price increases in the past three years has now come to an end. For the forecast period, indications are that the annual inflation rate will be close to 2 per cent. The general government budget surplus is likely to increase further. “It would be misguided to use this as a basis for deriving leeway for expenditure increases and tax cuts. Adopting forward-looking financial policy means that there is little scope for action as the surpluses are attributable to temporary phenomena such as high economic momentum as well as low interest rates,“ said Kooths.

Euro area economy has recovered; ECB now needs to tighten monetary policy

Indications are that a sustainable economic recovery is underway. The economic researchers at the Kiel Institute for the World Economy expect GDP to increase by 2.2 per cent in the current year and in the coming two years by 2.1 and 1.9 per cent, respectively. “Against the backdrop of the election victories of more moderate candidates in the past, high economic momentum and the further decline in unemployment, political risks in the forecast period meanwhile appear to be less menacing. Nevertheless, the forthcoming EU exit negotiations with the United Kingdom and the Italian parliamentary elections in the spring of 2018 have the potential to slow down the European economy,” said Kooths.

For the time being, however, the experts perceive the upward forces to be intact – according to numerous early indicators, the more robust expansion is likely to continue, the economy will continue to be underpinned by low interest rates, and the financial policy stance probably is slightly expansionary in the forecast period. Meanwhile the general inflation rate once again is substantially higher than one per cent.

“The European Central Bank no longer has any cause to continue holding onto its ultra-loose monetary policy. In view of the economic facts unfolding at present, the ECB is obliged to tighten its monetary policy reins again. To this end, it will first of all need to take up its reins again and communicate a clear exit scenario to the markets. This may be difficult enough as it is, but it will not become any easier by continuing to pump liquidity into the markets. One of the primary factors contributing to a recovery in the euro area is that economic participants once again need to be able to calculate on the basis of interest rates determined by the market,” said Kooths.

World economy in an upswing

Following a slightly subdued start to the year, global output growth gained momentum once again in the second quarter of 2017. For the first time in a lengthier period, the economy is simultaneously pointing upwards in nearly all major economic areas. After growing by as little as 3.1 per cent last year, the IfW researchers expect global output growth, calculated on the basis of purchasing power parities, of 3.7 per cent (2017) and 3.8 per cent (2018).

“However, not only did asynchronous economic trends of the world economy in recent years dampen the pace of global economic expansion; it also led to the big countries currently being in very different phases of the economic cycle. Accordingly, there will probably not be a protracted, robust global economic upturn of the kind that developed prior to the global financial crisis,” said Kooths.

For 2019, the researchers expect global economic expansion to slow down to 3.6 per cent. “Economic policy risks associated with the change of government in the United States have slipped into the background in view of the obvious problems in implementing campaign promises made. Risks to the forecast are currently based on political imponderables and possible problems in connection with the forthcoming normalisation of monetary policy,” said Kooths.