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Economic Forecast: Inflation Close to 2 % by 2018

In their latest economic forecast, researchers at the Kiel Institute predict GDP growth in Germany of 1.9 percent for 2016, 1.7 percent in 2017, and 2 percent in 2018. After adjusting for the relatively large number of working days that will be lost to public holidays in 2017, the figure for that year is equivalent to 2 percent. “Following the slowdown in the third quarter, when economic output rose by only 0.2 percent, leading indicators suggest the economy will pick up speed by the end of the year,” said Stefan Kooths, Head of the Forecasting Center at the Kiel Institute. According to the latest analysis the experts do not expect the Brexit vote in the UK to have a significant impact on the German economy. “The long-term effects of the presidential election in the United States and the constitutional referendum in Italy are difficult to predict at the moment, but the short-term consequences are likely to be limited,” added Kooths.

The main driver of the extended upturn in Germany remains the domestic economy. While private consumption is expected to slow due to rising inflation, this will be offset by the boost to investment provided by the ongoing availability of low-cost finance, especially in the housing sector. The construction industry continues to operate at full capacity. The current order backlog is the highest in 16 years. German exports are expected to grow considerably thanks to significantly improved business prospects in the relevant foreign markets. The researchers predict an upturn in the US economy, a sustained recovery in the euro area, and a better outlook in the emerging markets. Price competitiveness should also improve slightly over the next two years due to weak euro. In addition, the researchers expect a substantial increase in imports.

Unemployment continues to decline, inflation increases, budget surpluses remain

While employment growth has slowed sharply of late, conditions in the labor market remain good. Driven by the sustained economic upturn, the continuing favorable relationship between real wage costs and productivity, and the expansion of the labor supply due to immigration, employment growth will likely remain on a strong upward trajectory in the course of 2017 and 2018, with unemployment expected to fall below 6 percent. According to a recent projection, approximately half of the refugees available for work in Germany will be in employment, an estimated quarter of them will be registered as unemployed, a further quarter will be participating in employment programs.

Given the dynamic growth of the economy, the researchers expect inflation to reach 1.8 percent by 2018. However, they do not anticipate a long-term increase in oil prices, despite the recent agreement to cut production: “The OPEC states and other oil-producing countries have been running at maximum output over the past few months, which means supply remains high due to this surplus,” said Kooths. “Also, past experience suggests that these countries will not stick to the agreed quotas.”

Public spending rose by more than 4 percent during 2016, in part due to the considerably higher costs associated with refugee migration and the significant pension increase in the middle of this year. Thanks to buoyant tax revenues and major savings in interest charges, a budget surplus of around EUR 14 billion or 0.4 percent of GDP will nonetheless be achieved. This combination of high public spending and even higher revenues is expected to continue over the next few years, with the surplus remaining at around 0.5 percent of GDP.

Global economy is on the Up again

The global economy bottomed out in the course of 2016. Global production will improve from a modest 3.1 percent this year to 3.5 and 3.6 percent in the next two years, based on purchasing power parity. The advanced economies will continue to expand, at a slightly faster pace. This process will be underpinned by continuing expansionary monetary policy, fiscal stimulus—not least in the United States—as well as a gradual acceleration in wage growth. On the downside, purchasing power will no longer be supported by falling energy costs. The researchers predict gradually stronger growth in the emerging markets during the forecast period, but progress is expected to be modest due to the persistently low level of commodity prices and, in many cases, unresolved structural problems.

Comments by Stefan Kooths on the latest forecast: “A fragile economic environment”

“The expansion in Germany is taking place in what is still an extremely fragile monetary environment. The German economy is currently operating at near normal capacity, which, viewed in isolation, is ideal in terms of stabilization policy. However, the circumstances under which this development is occurring are neither normal nor ideal. In particular, the formation of interest rates in the capital markets remains subject to the influence of ultra-expansionary monetary policy in the euro area. The longer this intervention continues, the more the price of goods will be affected by an artificial interest rate signal. This will inevitably lead to a distortion of production structures. While this effect may not be particularly serious during a typically short-term and economically justified shift in monetary policy, it becomes increasingly significant if a low interest rate policy ends up being the status quo. As a result, both the real economy and the financial sector become more susceptible to crises, which is hardly conducive to the required normalization of monetary policy. These serious side effects of an ultra-expansionary policy over an extended period of time are not reflected in the economic forecast figures—in fact, the opposite is the case. The extremely favorable financing conditions are stimulating the German economy. It is therefore important to be aware that the high rates of growth in domestic economic performance we have forecast for this year and the following two years should not be viewed as evidence of a wholly benign macroeconomic development.”

The complete forecast can be found here.