Kiel Institute Economic Forecast: Slowdown in Germany Is Only Temporary

Despite lowering their GDP growth forecast for 2018, the economic researchers at the Kiel Institute for the World Economy (IfW Kiel) predict a continued boom period for the German economy. “The recent economic slowdown doesn’t mark the start of a downturn,” said Stefan Kooths, Head of the Forecasting Center at the Kiel Institute. “The current boom still has a way to go, even though the end is getting closer.”

The start of the year saw a lowering of business expectations and there was a significant fall in both industrial orders and exports. In the view of the Kiel Institute experts, this was partly due to the punitive tariffs that were either threatened or imposed by the United States, China, and the EU. Other inhibiting factors included the flu epidemic, strikes, and the large number of public holidays.

For the current year, the researchers have downgraded their forecast for GDP growth from 2.5 percent to 2 percent. The equivalent forecast for 2019 remains unchanged at 2.3 percent. Strengthening growth will be driven by significant improvements in household income and buoyant activity in the construction sector.

“The slower pace of the German economy in the first half of this year is the equivalent of hitting turbulence when flying,” added Kooths. “Output is expected to accelerate again from the middle of this year, mainly due to strong domestic drivers and a robust global economy. This increasingly raises the question of when production capacity in Germany will be so overstretched that cracks start to appear in the recovery.”

Domestic economy is driving growth

Household incomes are expected to grow appreciably thanks to the continued positive outlook on the labor market, both in 2018 and especially next year, as well as the federal government’s tax cuts and expansion of benefits. The latter include the improvement of pension benefits for women who took maternity leave prior to 1992, child support for first-time homeowners, and investment and support programs for infrastructure, education, and the job market.

According to the researchers, consumer spending will rise by 1.6 percent in the current year, followed by a healthy 2.5 percent in 2019—one of the highest increases since German reunification. Unemployment is expected to fall from last year’s 5.7 percent to 5.2 percent in the current year and 4.9 percent in 2019.

Construction companies will likely gradually expand their capacity as the favorable outlook continues. Homebuilding in particular is expected to grow strongly thanks to rising private incomes and continued low interest rates, with around 4.5 percent higher output forecast for this year and next.

“The signs of overheating in the German economy are particularly apparent in the construction sector,” said Kooths. “There is an acute shortage of labor, and prices are rising steeply.” The general shortage of domestic production capacity during the current and coming year will lead to an overall inflation rate of around 2 percent.

Business investment will probably continue to see moderate growth, partly inhibited by the high degree of uncertainty caused by various international factors.

Exports set to grow again

Following a significant decline in exports at the start of this year—especially to the US and UK due to the strength of the euro—the Kiel Institute researchers are predicting a renewed and significant increase. Thanks to robust conditions in export markets plus a weakening of the euro, exports are expected to increase by 3.4 percent in the current year and 4.9 percent in 2019.

With regard to public finances, the current surplus is likely to shrink slightly. While the federal government can look forward to new record revenues as the booming economy boosts social security contributions and payroll taxes, this will be more than offset by further rises in expenditure. This is especially true in the area of pensions, where the federal government plans to generally increase pensions, to equalize pension payments between east and west, to introduce additional parental leave pension benefits and a basic pension, and to improve disability provisions.

Significant geopolitical risks could impact the economy

“The current economic situation is subject to considerable risks and uncertainties,” said Kooths. “The trade and security policies being pursued by the United States, along with political uncertainty in the European Union, will continue to pose substantial political risks that could significantly dampen the pace of economic growth.

“Meaningful tariffs on the import of cars and car parts into the United States could have a major impact on manufacturing output in a number of countries where these particular exports form an important part of the domestic economy. In addition to Mexico and Canada, this would affect South Korea, Japan, and Germany in particular. We are also seeing growing political uncertainty in the eurozone, much of it triggered by the recent formation of a new government in Italy. Finally, there is a risk that the upcoming normalization of monetary policy will create sharp uncertainty in capital markets, which could then lead to further problems, especially for emerging economies.”

Global economy: positive outlook despite significant risks

After a slow start to the year for the global economy, output is expected to increase considerably during the coming months. For 2018 and 2019, the Kiel Institute researchers have scaled back their forecast for global production growth by 0.2 percentage points each to 3.8 percent (2018) and 3.6 percent (2019). A marked pickup in core inflation is likely.